For years, critics have claimed that the Federal Housing Administration's $1 trillion Mutual Mortgage Insurance fund would require a bailout.
The fund's required buffer has fallen well below the mandated level of 2% of the insured portfolio. While the actual ratio, when last measured in November, stood at 0.24%, what seems remarkable at all is that five years into the collapse of the housing market, the fund did not implode and go the way of Fannie Mae, Freddie Mac and a slew of other well-known but now defunct mortgage portfolio lenders.
So, we might ask the question, how much of the fund's solvency is due to FHA being lucky or smart?
It turns out that the longevity of the fund's solvency is due to three events: the sharp decline in FHA's market presence during the housing boom; FHA's countercyclical role during the housing crisis and flight of private capital; and higher mortgage insurance premiums in recent years.
The years preceding the crisis were not kind to FHA. The advent of private-label securitization and the proliferation of nonprime mortgage products significantly eroded the market presence of FHA during this period. Historically, FHA made up anywhere from 10% to 15% of the mortgage market but during 2005-2007 the agency accounted for less than 4%. The FHA's marginalized position at the time has wound up being a blessing in disguise as the books of business from 2005 to2008 have experienced abnormally high loss rates.
Looking across all loans from the Mortgage Bankers Association national delinquency reports, as of this year's second quarter, 59% of seriously delinquent loans (those 90 days or more past due or in foreclosure) were from the 2005 to2007 vintages and another 16% were from 2008-2009. These loans were backed by properties purchased at the peak, which then experienced the full drop in prices along with the worst of the increase in the unemployment rate. Yet for FHA, 47% of the seriously delinquent loans are from 2008-2009, and 9% from 2010 or later. FHA was a bit player in the market during the boom, and as a result, FHA experienced far less exposure to the worst of the drops in home prices, and thus lower losses.
As private capital retreated from the mortgage market during the crisis, the FHA's share of the market rose significantly in the 2008-2010 period to 13% to 20%, and more than 40% of the purchase mortgage market. Today, FHA, the Department of Veterans Affairs, and other government housing programs account for more than 35% of the purchase market, largely due to their insuring of loans with low down payments. As implied above, the credit quality of the crop of loans originated from the second half of 2008 to the present is very high on a relative basis, despite the FHA's market focus on traditionally higher credit risk borrowers.
Thus the vintage composition of FHA's portfolio has, more than any other attribute or policy action, kept it afloat. That's not to say that the credit risk it has borne over the years isn't concerning. The significant erosion in their capital ratios is reason to call attention to the fund.
To its credit, the FHA has taken actions over the last few years to shore up its reserves. It raised premiums as well as tightened underwriting standards in the years following the crisis. For example, average credit scores of FHA borrowers in recent years have been around 700 or about 50 points higher than in 2007 and 2008. And the performance of successive books of business has continued to improve, with 2010 better than 2009, 2011 better than 2010, and 2012 already appearing stronger than 2011.
Despite these actions, the fund is not out of the woods and much depends on the direction of home prices over the next several years. The basis for the 2011 projections was the Federal Housing Finance Agency's house price index. A key assumption in the 2011 MMI Fund actuarial report to Congress was that home prices would decline no more than 5.6% and improve thereafter. For FHA, the good news is that home prices fell by about half that amount last year. If housing continues to show signs of stabilization, it is possible that the MMI Fund will not require any assistance.
There is little solace to be taken here by FHA should the MMI Fund remain solvent as its fortunes have benefited from favorable market circumstances in addition to more effective risk management. The agency has been on a path to strengthen its risk management and governance practices since the crisis, and it has taken some important steps to better control its risk profile. However, it cannot take full credit for a favorable result. It has been both lucky and smart.
Clifford V. Rossi is the Executive-in-Residence and Tyser Teaching Fellow at the Robert H. Smith School of Business at the University of Maryland. Michael Fratantoni is the Vice President of Single-Family Research and Policy Development at the Mortgage Bankers Association.