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FHA’s Funding Woes Add Momentum to Housing Finance Overhaul

By Clea Benson
(Bloomberg News, 1/8/12)

Financial troubles at the Federal Housing Administration are stirring political momentum for changes to the U.S. government role in mortgage finance, even as Fannie Mae, Freddie Mac and the housing market are recovering.

President Barack Obama’s 2013-2014 budget next month is likely to reflect that the FHA will require taxpayer subsidies for the first time. The prospect of a bailout, coming after the $190 billion the U.S. has spent to prop up Fannie Mae and Freddie Mac, adds urgency to the congressional housing debate.

“FHA is in a place, solvency-wise, where we have to deal with reforms,” Senator Bob Corker, a Tennessee Republican who sits on the Banking Committee, said in a December interview with Bloomberg Television. “That will probably be hand-in-hand with what happens with Fannie and Freddie.”

The FHA’s insurance fund could have a shortfall as high as $16.3 billion this year, according to a November projection from an independent actuary. While the losses largely stem from loans to homebuyers of modest means who didn’t make significant downpayments, lawmakers say the FHA should tighten its limits on borrowers at both ends of the market.

Founded during the Great Depression to spur lending to low- and moderate-income families, the agency now insures $1.1 trillion worth of mortgages, nearly quadrupling its share of home-purchase loans from 4 percent in 2007 to more than 15 percent now. Increasingly the FHA serves wealthier borrowers who in the past would have been financed through the private market.

Distinct Roles

Together, FHA, Fannie Mae and Freddie Mac back about 90 percent of home loans, filling the gap left by the collapse of private mortgage lending in the wake of the 2008 credit crisis.

Any overhaul of housing finance should take into account the distinct roles of all three players as well as the function of private capital, Fannie Mae chief executive officer Timothy J. Mayopoulos said in an interview today.

“Policymakers should look at the totality of the system as opposed to focusing on just one part of it as they think about reform, because the way the different pieces fit together is understanding the results we’re going to get,” Mayopoulos said at a Bloomberg Government breakfast in Washington.

The entities operate under different mandates. The FHA insures loans, making lenders whole if borrowers default. Since its inception in 1934, the FHA has morphed from insuring 20-year loans with a 20 percent downpayment to backing 30-year loans with downpayments as low as 3.5 percent.

Expanding Share

Fannie Mae and Freddie Mac, which were seized by regulators in 2008 after investments in risky mortgages pushed them toward insolvency, buy loans and package them into securities, guaranteeing interest and principal payments. After years of taxpayer support, the two companies began reporting steady profits last year.

As the FHA has expanded up-market, it has backed borrowers once served by Washington, D.C.-based Fannie Mae and Freddie Mac of McLean, Virginia, while those two enterprises buy loans that might have been financed by the private market five years ago, said Brian Chappelle, a bank consultant and former FHA official.

“No one is serving that first-time homebuyer, lower-income homebuyer market,” Chappelle said.

Setting Targets

Republicans and Democrats are calling for changes at the FHA that will clearly define its mission, determine an acceptable loan-failure rate, and set a target for its share of U.S. home loans.

Trying to prevent a shortfall in its insurance fund, the FHA announced in November that it would increase the annual fee it charges borrowers for its insurance by 10 basis points, charge more to insure larger loans and auction some delinquent mortgages to investors to avoid foreclosing on them.

Whether those measures and rising home prices will be enough to keep the agency solvent isn’t clear. The FHA is legally required to keep enough cash on hand to cover all projected future losses; White House budget writers are currently running the numbers.

South Dakota Democrat Tim Johnson, chairman of the Senate Banking Committee, said at a hearing in December that he would seek legislation to restore FHA’s fiscal health “if the administration’s actions and proposals will not be sufficient.”

The FHA’s stopgap action is “not as good a coordinated plan as we’d like to see,” said Guy Cecala, publisher of Inside Mortgage Finance, an industry publication based in Bethesda, Maryland. “It’s basically the result of FHA suffering losses and feeling like they’ve got to jack up premiums.”

Filling Vacuum

Without congressional action, the FHA has few options other than pricing changes, and that could further distort the mortgage market. Changes in FHA policy will drive business to Fannie Mae and Freddie Mac or vice versa, with little progress in making room for private financiers, Cecala said.

“Whichever one you curtail first, the other one will end up filling the vacuum,” Cecala said. “To the extent that FHA raises their premiums, Fannie and Freddie loans become more attractive.”

Congress has already helped skew the FHA’s lending toward wealthier borrowers. Historically, Fannie Mae and Freddie Mac have had higher loan limits than the FHA. Lawmakers last year raised the maximum size of FHA loans to as much as $729,750 in high-cost areas including Los Angeles and Washington, D.C., while leaving limits for mortgages backed by Fannie Mae and Freddie Mac at $625,000, essentially pushing buyers of more expensive homes to FHA.

Different Mission

In 2007, about 7 percent of the FHA’s loans for home purchases went to buyers earning more than $100,000 a year. By 2011, that share had more than doubled to 15 percent, according to data compiled by the Federal Reserve.

“Right now, FHA can insure loans for the very wealthiest,” said Karen Shaw Petrou, managing partner of Washington-based Federal Financial Analytics. “It’s not their mission. For all the talk of mission, FHA right now insures the upper-middle-class loan limit.”

Meanwhile, the number of low-income homebuyers served by FHA has been dropping. FHA made 152,896 loans for home purchases to low-income borrowers in 2011, down from 171,890 in 2010, an 11 percent decrease.

Despite recent improvements in underwriting, the legacy of FHA’s past practices is still being felt on its books: The agency’s loan default rate is 10 percent, nearly three times the 3.5 percent rate at Fannie Mae and Freddie Mac, according to data from the Mortgage Bankers Association. Critics say the FHA should charge higher premiums to borrowers with low credit scores and higher debt-to-income ratios.

Foreclosure Impact

Edward Pinto, a housing specialist at the American Enterprise Institute, an organization that advocates free-market principles, released a study in December showing that 40 percent of the loans on the FHA’s books went to borrowers at a high risk of foreclosure, who either had credit scores below 660 or a debt-to-income ratio above 50 percent.

“How many foreclosures are acceptable for the FHA program, recognizing the impact of foreclosures on neighborhoods?” Mark Goldhaber, a North Carolina mortgage industry consultant, said in an interview. “You can do low-down-payment lending. What you can’t do is a whole series of stacked risk factors.”
At a recent hearing before the Senate Banking Committee, Shaun Donovan, Secretary of the Department of Housing and Urban Development, the agency in charge of FHA, said officials are considering raising minimum credit scores for FHA loans and taking other steps to shore up the insurance fund.

No Promises

Donovan said he couldn’t promise that the FHA wouldn’t have to seek help from the Treasury. He urged Congress to give the agency more authority to change its products to mitigate risk.

Some regulators, analysts and lawmakers are hoping that such changes to the FHA would be a first step toward reaching a consensus on a broader overhaul of mortgage finance that includes Fannie Mae and Freddie Mac. The Obama administration and lawmakers from both parties have said the two companies should shrink or be replaced but haven’t found common ground on how to achieve that.

“If policymakers begin with the role FHA should play in the future in terms of what borrowers would have access to this program, then it should be easier to consider the government’s role in the remainder of the mortgage market,” Edward J. DeMarco, who runs the regulator overseeing Fannie Mae and Freddie Mac, said in a Dec. 6 speech in New York.

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