The U.S. economy is still trying to recover from the crash it experienced after the housing bubble burst. Fannie Mae and Freddie Mac were bailed out to the tune of $187 billion and remain in conservatorship, wards of the state. The single saving grace was that many of those loans had private mortgage insurance covering the first 30 percent of loss; otherwise the taxpayers would have received a bill for an additional $50 plus billion.
Washington should have learned a valuable lesson: private capital is a good thing and government should be encouraging more of it in the housing finance market. Alas, to judge by the administration’s recent actions, the lesson appears to have escaped them, even as Congress is right now looking for ways to prevent another catastrophe.
The only way to reduce taxpayer exposure in housing finance is to fully utilize the private mortgage insurance industry. They are the only stable, well-regulated, source of private capital taking credit risk in the housing market right now. The alternative is to increase use of the government’s program that guarantees 100 percent of mortgages — meaning taxpayers are on the hook for the whole loan amount if the homeowner defaults. That is way too much risk, but it’s a risk that policymakers seem content to ignore.
The administration’s policies and price cuts at the Federal Housing Administration – the latest coming on January 26 — are squeezing the private sector competitors. President Barack Obama and the FHA are engineering things so that just about anyone with a modest down payment who wants a mortgage needs Uncle Sam to get it.
FHA was originally conceived as a vehicle only for low- and moderate-income individuals seeking modest homes and mortgages who were not served by the conventional market. Today, FHA is insuring very large mortgages for people in all income brackets (including ones that absolutely can get mortgage financing in the conventional market). Thanks to prodding from the administration, the FHA mission’s has been transformed in a way that grows the government’s market share, puts private capital in the backseat, and exposes the taxpayers to even greater risks due to their 100 percent guarantee.
Private industry analysts say the FHA is a dangerous diversion from the right way back to a mortgage market. In the end, policies like this, when taken to their logical conclusion, might push the private sector out of the market completely because it will not be able to compete against the government. For starters, FHA does not have to meet the same safety and soundness requirements as the private sector competitors. This allows the FHA to price their products much more cheaply than the private sector. In January FHA announced a 37 percent reduction in its insurance fees, severely tilting the market towards the FHA. This also means that FHA has a drastically smaller cushion to absorb losses, but apparently that is a concern for a later day (once again).
FHA also continues to insure large mortgages. During the depths of the recession, the government increased the amount of the loan FHA could insure from roughly $363,000 in 2008 to $625,500 today. These loans are directly competing with loans insured by the private market and are only serving well-off individuals buying expensive homes.
This is further exacerbated by the fact that, unlike private loans, FHA loans are “assumable” — meaning the mortgage can be transferred from today’s borrower to another in the future at today’s prices/interest rates. For the moment interest rates are historically low but, as the economy recovers, demand for capital increases, and interest rates go up, existing FHA mortgages (with their low interest rates) will be even more attractive to new buyers! As long as FHA loans are assumable the FHA has future credit risk for unknown buyers that they have not factored into their risk models.
There are other concerns. Dodd Frank requires all mortgage lenders to make sure borrowers demonstrate an “ability to repay.” The Consumer Financial Protection Bureau wrote a series of regulations to govern that examination, setting limits in underwriting criteria to how much debt relative to income a new homebuyer can take on; then the FHA wrote their own much more lenient rule.
They don’t match. Instead, we have one set of rules for loans insured with private capital and another for those insured by the FHA. Lenders who meet these rules are protected against charges of fraud if they follow the CFPB or FHA’s rules, so it’s no surprise that lenders will lean towards the more generous FHA definition.
All of this should have taxpayers’ hair standing on end for, unlike Fannie and Freddie, there is no special legislation required to bail the FHA out. It’s part of the appropriations process, bears the full faith and credit of the U.S and gets from the taxpayers what it needs to stay in business. This means policymakers pushing these loans to the FHA may be setting us all up for an ongoing bailout thanks to their recent “sale” prices on FHA insured-loans.
Fool me once, shame on you. Fool me twice, shame on me. Together the Obama administration and the House and Senate committees looking at the whole business are setting the mortgage market on a path to where — as it now is with student loans — anyone who buys a house will have a government guaranteed loan. This is about as far from the founder’s vision of limited government as one can get. Instead, policymakers should be taking steps to strengthen the private mortgage insurance industry to minimize the exposure of us all to bad policy.
Peter Roff is a senior fellow at Frontiers for Freedom, a Washington-based public policy organization.