Recent Attacks on FHA Are Wrongheaded
The agency's annual independent actuarial report is expected to show that its capital reserves have been depleted by rising levels of defaults. FHA could shore up its finances by increasing its enforcement against banks and other lenders, but it may also need to tap the Treasury for the first time in its history.
An independent audit found that the Federal Housing Administration's capital reserve ratio fell into negative territory, meaning the agency may need a bailout from the Treasury Department for the first time in its 78-year history.
As policymakers mull the future of U.S. mortgage policy, Federal Housing Finance Agency chief Ed DeMarco sees a potential starting point in an entity he does not regulate: the Federal Housing Administration.
The Federal Housing Administration has been getting a lot of undeserved bad press lately.
The onslaught began last month after the agency released a sobering financial report, then accelerated last week when the New York Times reported on an alleged "pattern of risky lending" in the agency's mortgage insurance program.
The Times piece, penned by columnist Gretchen Morgenson, relays the findings of a controversial new report from Edward Pinto of the conservative American Enterprise Institute. Pinto's study takes on an important issue—the performance of FHA-insured home loans—but draws conclusions based on ideology rather than a cold appraisal of the facts. By relying entirely on one man's misleading data and unfounded opinions, Morgenson has done a grave disservice to a critical federal program.
The report in question argues that the FHA is "financing failure" for working-class families by peddling high-risk loans to unworthy borrowers, based on an analysis of loans insured in 2009 and 2010. Pinto concludes that the agency's basic business model—insuring long-term, low-down-payment loans to borrowers with less-than-perfect credit—puts homeowners at an unacceptably high risk of default with negative consequences for communities.
Nothing could be further from the truth.
Since the 1960s, the FHA has promoted sustainable homeownership for creditworthy low-wealth families by backing loans with a down payment of as little as 3.5% and a term of up to 30 years. In the wake of the worst housing crisis since the Great Depression, the agency is facing significant losses on loans made between 2006 and early 2009—but the FHA business model is not to blame.
Here are the facts. According to the Mortgage Bankers Association, roughly 9% of FHA-backed loans are "seriously delinquent" today, meaning the borrower has missed at least three consecutive payments or is in foreclosure. That number is slightly higher than the rate for prime loans (5%) but less than half the rate for subprime loans (22%).
The agency's recent loans are performing especially well, thanks to protections put in place by Congress and the Obama administration. Just 6% of FHA-backed loans made in 2010 and 3% of those made in 2011 are seriously delinquent today. The agency's 2010, 2011, and 2012 books of business are expected to be its most profitable ever, bolstering the insurance fund by a combined $22.7 billion, according to independent auditors.
Roughly 70% of these well-performing loans had a down payment of less than 5%, more than 90% had a 30-year term, and about two-thirds of borrowers had a FICO credit score of less than 680, according to FHA data. So much for the agency's flawed business model.
Pinto's study pays special attention to the impact of FHA lending on low- and moderate-income communities. He finds that 44% of all FHA loans are in lower-income zip codes with higher-than-average default rates, implying that the agency is overly-concentrated in high-risk neighborhoods. By allowing roughly one-in-ten borrowers to fail, he concludes, the FHA is doing more harm than good in these communities, and therefore should tighten its credit box to pull back lending. (He presents no hard evidence that a one-in-ten failure rate is a reasonable benchmark.)
There's a lot to unpack here. First, there's something mildly ridiculous about accusing the FHA of lending too much in lower-income communities. In Pinto's own words, the FHA's core mission is to help creditworthy low- and moderate-income families achieve sustainable homeownership. By scaling back lending in low- and moderate-income neighborhoods, he is essentially urging FHA to stop fulfilling its mission so that it can gradually return to its mission.
Second, Pinto fails to mention that these default rates occurred after the worst housing crash since the Great Depression, in which housing price declines collided with high unemployment rates to create a perfect storm of foreclosures. That crisis was precipitated not by government-backed loans—as Pinto has repeatedly alleged—but by the proliferation of privately-funded, poorly-underwritten subprime mortgages, particularly in low-income neighborhoods.
Of course these neighborhoods have higher foreclosure rates. Many subprime products were designed to fail, featuring low teaser rates that shot up after a few years or principal balances that grow rather than shrink over time. That type of predatory lending bears little resemblance to the plain-vanilla, 30-year, fixed-rate loans insured by the FHA. There may be a correlation between FHA-backed lending and foreclosure rates in a particular community, but there certainly isn't causality.
Third, and most important, Pinto focuses on the cost of foreclosure without considering the FHA's contribution to these neighborhoods since the crisis began. If FHA insurance weren't available under reasonable terms, it would have been much more difficult for low- and moderate-income families to get mortgage credit since the crisis began. As a result, home prices would have declined precipitously beyond already-depressed levels – by as much as 25%, according to one estimate from Moody’s Analytics – leading to far more foreclosures on all homes, not to mention additional job loss, lost household wealth and a far deeper or more prolonged recession.
That counter-cyclical support is a key part of the agency's mission, and it understandably comes with some costs. If the foreclosure crisis were a fire, Pinto would be blaming the firefighters for getting the house wet.
In the coming months, we hope there is a serious debate about the FHA's role in the housing market and the overall role of the government in housing finance. That will require us to sort facts from partisan nonsense, and here's hoping this report doesn't make the cut.
John Griffith is a policy analyst with the housing team at the Center for American Progress.