What FHA Should Do: A Prescription for Prudence
For those who didn’t get enough of “Mortgage Meltdown” (the original) the first time around, the remake is sure to be appearing soon in a nearby theater.
As the philosopher George Santayana famously noted, “Those who do not remember the past are condemned to repeat it.” Indeed, it is frightening to consider that the same perverse incentives from the federal government that caused the housing bust of 2007 are hard at work again: namely, getting more people to buy homes, regardless of their ability to pay the mortgage or the government’s ability to adequately price the risk they face when those borrowers default. These efforts proceed apace, as if without memory of the economic calamity that resulted from the mortgage binge-then-bust that factored so heavily in the Great Recession of 2008, not to mention the subsequent $1.7 billion bailout of the Federal Housing Administration (FHA) in 2013. And rather than behave more conservatively in the aftermath of such austere lessons, the Obama Administration is encouraging FHA to pursue risky policies that, if left unchecked, foreshadow yet another housing bailout.
Understandably, given the enormity of the last mortgage crisis, the housing finance market has been somewhat restrained. To entice lenders to restore FHA marketshare, the agency has been aggressive in undercutting market competitors in the mortgage insurance sector, while operating well below its minimum statutory capital requirements.
Rather than continue down this road to ruin, a handful of reforms would put FHA back on a prudent path. These include: restoring FHA’s historical loan limits; limiting FHA eligibility to first-time home buyers; requiring FHA and the Consumer Finance Protection Bureau (CFPB) to have identical qualified mortgage standards; reducing FHA’s mortgage guarantee below its current 100% level; establishing reasonable FHA premiums; authorizing risk-sharing between private insurers and FHA; requiring identical calculations to avoid disparate pricing policies between FHA and the government-sponsored enterprises (GSEs), Fannie Mae and Freddie Mac; and compelling housing counseling for borrowers.
Restore Historical FHA Loan Limits. Congress gave FHA the authority to radically increase their loan limits to be equivalent to the GSE loan limit (roughly $625,000 in high-cost areas). This policy is driving business toward the FHA and away from the private mortgage insurance (MI) industry, which is ready, willing, and able to insure many of these rather large mortgages to rather wealthy borrowers. Congress should recalibrate FHA’s loan limits according to the median home price for that area for the preceding calendar year. Doing so would scale back FHA’s market share, reduce taxpayer exposure and likely improve FHA’s financial condition, while refocusing FHA on its historical mission.
Limit FHA Eligibility to Low- and Moderate-Income, First-Time Borrowers. FHA should explicitly limit its insurance to first-time home buyers. Further, FHA should only insure loans for borrowers who make the median household income, or less, in their area. Today, FHA’s taxpayer subsidy is being used to benefit a substantial number of borrowers who already own a home and are making well over the median income in their area. These changes would ensure that FHA’s limited resources are only used to insure loans for those borrowers who are unable to access financing in the conventional market, thereby returning FHA to its original mission, while enabling private mortgage insurers using private capital to serve their historical share of the low down payment market.
Qualified Mortgage Symmetry or Manual Underwriting. Requiring the CFPB and FHA to have identical qualified mortgage standards means that the CFPB rule should permit loans that exceed the 43 percent debt-to-income ratio only if the borrower has well-documented compensating factors (as defined by the FHA). For FHA loans that exceed the 43 percent debt-to-income standards, the loans should be manually underwritten by the FHA (e.g., the FHA Home Ownership Centers). Today, only lenders are looking at these mortgages that are considered exceptions to FHA’s own policies. And the lender decides whether to place FHA at risk by authorizing the FHA insurance. This delegation of authority from the government (FHA) to lenders on these type loans is incredibly risky and unsustainable. The FHA should be making these decisions and reviewing them on a case-by-case basis rather than just taking the lenders’ word for it.
Reduce the FHA’s Guarantee Below Its Current 100 Percent Level. An essential feature of mortgage insurance that is lacking in the FHA is coinsurance on the part of all parties to the transaction. For private MI, coinsurance means that the private MI stands in the first position of loss behind the borrower’s equity and is generally 25–35 percent of the loan amount, which covers most (but not necessarily all) of the losses that the parties to the transaction experience. This serves as an important incentive to avoid foreclosure. FHA, on the other hand, insures 100 percent of the loan amount if the loan goes into foreclosure so that the loan originator lacks any meaningful risk of loss. As a result, the FHA guarantee does not properly align incentives among originators, borrowers, and the FHA. Reducing the 100 percent coverage down to an actuarially sound level commensurate with the conventional market practice will provide lenders with an incentive not to foreclose, decrease taxpayer risk, and allow more prudent risk underwriting by third-party private mortgage insurance companies before the loan is made.
Establish Reasonable FHA Premiums. FHA should (1) increase its annual premium by 50 basis points immediately for the most creditworthy borrowers who would be better served by private MI, and (2) increase its annual premium by 10 basis points every 6 months until it reaches its statutorily required 2 percent capital ratio. Doing so would scale back FHA’s market share, reduce taxpayer exposure, improve its financial condition, and refocus FHA on its historical mission.
Risk Sharing. In recent months, Fannie Mae and Freddie Mac have introduced “credit risk” programs to essentially transfer the risk they face when a borrower defaults on their mortgages to the private sector. FHA should be doing the same. Risk-sharing between private mortgage insurers (who have the technical expertise and capacity to take on some of the FHA’s risk) and FHA will introduce private-sector discipline to FHA underwriting and reduce taxpayers’ exposure to losses.
Tethered Analytics. FHA and the GSEs use different numbers when calculating home price appreciation, which allows them to draw different conclusions about how to price future risk and the fees associated with that insurance. The calculations should be completed under the same rules in order to avoid incongruous pricing policies between the GSEs and FHA.
Compulsory Housing Counseling. FHA should require all of its borrowers to undergo housing counseling prior to endorsing the mortgage for insurance. By teaching consumers basic principles of home ownership and money management, homeowners will learn budgeting, discipline, and strategies to increase their savings and the responsibilities of homeownership, which ultimately reduces the risk to the taxpayers
Similar to Santayana’s admonition about paying attention to the past is the adage about the definition of insanity: doing the same thing over and over again but expecting different results. Unless Congress asserts some of the policy prescriptions proposed herein, taxpayers should not be surprised when the 2007 “mortgage meltdown movie” is remade for new audiences who weren’t sufficiently traumatized or do not recall the original.
