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Don't Be Fooled by the FHA 'Bailout' Hysteria

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Friday's announcement that the Federal Housing Administration may soon need taxpayer support for the first time in its 78-year history is sure to energize critics of the government-run mortgage insurer.

It will be months before we know the final tab, but even the $16.3 billion estimate released today is a small price to pay for the agency's efforts to rescue the housing market.

Without the agency's help in recent years, it would have been much more difficult for middle-class families to access mortgage credit since the housing crisis began. As private capital fled the mortgage market, FHA insurance propped up demand for homes, preventing housing construction and sales from plummeting even further than they did.

According to Moody's Analytics, the agency's actions prevented home prices from dropping an additional 25%, which in turn saved 3 million jobs and half a trillion dollars in economic output.

Still, critics will be quick to make hay of the news, stoking public outrage over billion-dollar "bailouts," gross mismanagement of taxpayer risk, and imminent insolvency at the agency, which backs $1.1 trillion in home loans.

Don't buy any of it.

First, the agency's current financial troubles are not the result of a weak business model or the financial incompetence of federal bureaucrats, but of a "hundred-year flood" of  foreclosures during the worst housing crisis since the Great Depression, plus a couple of poor policy decisions.

The bulk of the agency's losses come from loans originated between 2007 and early 2009, during the peak of the housing bubble and just after it burst. A large percentage of those loans included so-called "seller-financed down payment assistance," an admittedly bad idea that cost the agency direly. In these transactions, sellers covered the required down payment at the time of purchase, but often fraudulently inflated the purchase price to make the transaction worthwhile.

The FHA tried to eliminate seller-financed loans from its programs for years, but met strong opposition from lobbyists and lawmakers. Congress finally banned them from FHA insurance programs in 2008 (the ban officially took effect in the second fiscal quarter of 2009) but significant damage was already done. If such a ban had been in place from the start, the agency could have avoided $15 billion in losses and likely would not need taxpayer support today, according to the actuarial report.

Meanwhile, the agency's more recent years of business are likely to be some of its most profitable ever, due in part to higher fees and new protections put in place by the Obama administration. It's worth noting that roughly 70% of loans made since 2010 - the "profitable" books - had a down payment of less than 5%, so the agency's basic business model still appears to work.

Second, Friday's announcement does not signal an imminent financial emergency at FHA; it's the byproduct of prudent budgeting.

FHA is not running out of money any time soon. The agency still has $30.4 billion in its coffers to settle insurance claims as they come in. But according to federal budget rules, FHA must hold enough capital to cover all expected claims over the next 30 years, which would require about $46.7 billion, according to FHA's actuaries.

That's where the taxpayer support comes in. When the agency does not have enough money to cover all expected claims, the U.S. Treasury automatically fills the gap. That's always been part of the agreement taxpayers made with FHA, dating back to the 1930s. Extending this support isn't a "bailout," it's fulfilling a legal promise.

All things considered, it's actually quite remarkable that the agency made it this far without requiring that support. In the wake of the crisis, most private mortgage insurers have either gone out of business or significantly scaled back their insurance activity, while FHA increased its business.

So don't be fooled by the "bailout" hysteria. In exchange for our support today, the FHA saved taxpayers hundreds of billions of dollars by preventing massive home-price declines, another wave of foreclosures, and millions of terminated jobs – all while outperforming its counterparts in the private sector.

Even the most fanatical budget hawks would call that a bargain.

John Griffith is a policy analyst with the housing team at the Center for American Progress.

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Comments (2)
As government insurance goes FHA has probably been the best run, and as bailouts go this one is small. But whether we need the government involved in backing the FHA is still an important question!
Posted by kvillani | Monday, November 19 2012 at 12:09PM ET
First you state that the agency helped save the market and then later you state that the agency participated in lending that inflated asset values. So which is it? You cannot claim to be both the problem and the solution and go on your merry way. The reason the FHA has had to step up is because of two reasons: 1) They are lending at rates that the private market has deemed to be to low relative to the risk/reward and 2) Gov't regulations have strangled lenders to the point that only the FHA and Fannie/Freddie are capable of still providing lending to anyone who wants a loan, whether or not they deserve it. A more salient solution would be to step out and let the market find true price discovery. Doing so would have been much better than the drug-out housing depression we've seen to date.
Posted by BankerBud | Monday, November 19 2012 at 4:25PM ET
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