Tag: fha loans

Advocates Complain Banks Not Putting FHA at Enough Risk

A constant narrative of the financial crisis is that banks out-smarted the government by taking excessive risks, and that if only we had empowered regulators, the whole crisis would have been avoided.  The truth, however, is that government was often the driver of excessive risk-taking, and nowhere is that more true than in the mortgage market.

One of the worst offenders has been the Federal Housing Administration (FHA).  Even today, one can get an FHA backed loan with only a 3.5% downpayment.  After the financing of seller concessions, the borrower can leave the closing table with zero, or even negative, equity.  FHA will even offer these low equity loans to subprime borrowers, those with the worst credit history.  If there’s anything to be learned from the financial crisis, combining high risk borrowers with low downpayment loans is asking for default.

Despite FHA’s loose standards, several lenders have responsibly chosen to impose higher underwriting standards than FHA.  Sadly instead of being praised for being slightly more responsible than FHA, these lenders are being attacked by so-called consumer advocates for not taking enough risk.

The Washington Post reports that a coalition of advocates is planning to file complaints against lenders who have higher standards than FHA, claiming that higher standards discriminate against minorities, since minorities on average have lower credit scores.  It seems some have learned nothing, continuing to push the very same policies that contributed to the crisis.  If anything, FHA should start moving in the direction of the more responsible lenders and improve its woefully weak underwriting standards.  Congress should also move in the direction of requiring meaningful downpayments on FHA loans, as well as shifting some of the credit risk back to the lender.

Reassessing FHA Risk

As the Federal Housing Administration edges closer to a taxpayer bailout due to the large number of risky mortgage loans it has insured, it continues to insist that no such bailout will be required. However, a new study from a group of economists at New York University finds that the FHA’s assurances might not be based in reality.

According to the study, the actuarial analysis FHA used to determine it won’t need a bailout seriously understates its exposure to risk:

  • More FHA mortgages are underwater than the FHA’s analysis identifies, and unemployment is naturally particularly high in areas where FHA borrowers are furthest underwater. Therefore, potential default costs are underestimated.
  • FHA’s analysis relies on house values that are inaccurate. Overvalued houses means the FHA could end up recouping less than expected on defaults.
  • Underwater FHA mortgages that were “streamlined” into new FHA mortgages are not properly accounted for, which further underestimates risk.
  • The FHA got clobbered on a previous no-downpayment assistance program. However, the current homebuyer tax credit can effectively eliminate downpayments on FHA loans, but its analysis doesn’t take this into consideration.

One of the study’s authors, Prof. Andrew Caplin, writes the following on his website:

Rather than looking to structure the markets of the future, they [policymakers] have stumbled along in business as usual mode, waiting for kind fate to save them. It may. Then again, it may not. Either way, this is not a good way to run a business, or a government for that matter.

How does he see this story playing out?

My best guess is that it will end with a crash in the housing finance sector, with the federal government forced by popular revulsion at mushrooming losses to remove itself almost entirely from the housing finance equation. The Resolution Trust Corporation will look like an amateur warm-up act…

The bottom line is simple. The continuation of “business as usual” is re-creating the essential problem that made the sub-prime crisis so disastrous. Once again, taxpayers have been forced to subsidize the private purchase of massive amounts of residential housing, and to offer guarantees against future losses, without any effort to reduce costs should their funding help turn some markets around. Warren Buffett made huge profits for his shareholders by investing in under-valued assets. By contrast, our leaders are making massive losses for taxpayers by investing in over-valued assets.

See this essay for more on the problems with housing finance and government intervention.

New HUD Same as Old

U.S. Department of Housing and Urban Development Secretary Shaun Donovan recently gave a speech in New York in which he spoke of a “new direction in housing.” If there’s one constant with cabinet secretaries, it’s that they all promise that their department will be new and improved. The following are a few of Donovan’s lines that deserve comment.

The Federal Housing Administration is providing another critical bridge to economic stability…And with nearly half of first-time buyers using FHA loans, it is clear that the FHA has been central to recovery.

Thanks to his predecessor, Alphonso Jackson, who was “absolutely emphatic about winning back our share of the market,” the FHA’s willingness to pick up the subprime lending slack when the housing bubble burst has opened the door for a potentially huge taxpayer bailout. In fact, the government hasn’t just come to dominate the housing finance market – it practically is the housing finance market. Thus, there are plenty of doubts as to whether the housing “recovery” Donovan speaks of is sustainable without the government crutch.

In crisis comes enormous opportunity for change – as Rahm Emanuel says, ‘a crisis is a terrible thing to waste.’ Ensuring we don’t starts with getting the government back into the business of building and preserving affordable housing. Homeownership is incredibly important. But if this crisis has taught us anything, it’s that it is long past time we had a balanced, comprehensive national housing policy – one that supports homeownership, but also provides affordable rental opportunities, and ensures nobody falls through the cracks.

Like his boss, Donovan’s use of the word “change” is just a euphemism for bigger government. His contention that the government needs to get “back” into affordable housing is laughable. When did it leave?

This crisis has illustrated that only the Federal government has the scale and mechanisms to deal effectively with some of the forces that caused it.

It was the federal government’s “scale and mechanisms” that helped cause the crisis! Only powerful institutions with national “scale” such as the Federal Reserve, Fannie and Freddie, and HUD had the power and potential to create such a nation-wide bubble, bust, and recession. Donovan wants the arsonist to put out the fire.

The Federal government can be a key partner in helping communities foster the kinds of synergies between housing, education, public safety, and health you’ve helped nurture at the neighborhood level.

Words like “synergy”, “nurture”, and “foster” are vacuous bureaucratic rhetoric. They are supposed to imply that the federal government can turn decaying urban centers into utopias with gobs of taxpayer money and bureaucratic meddling. That’s just bunk.

In my recent paper on three decades of scandals, mismanagement, and policy failures at HUD, I show that little has changed at HUD other than the individuals occupying the throne. The history of Shaun Donovan’s tenure is yet to be written, but his speech makes me pessimistic.

The Week in Government Failure

Over at Downsizing Government, we focused on failures in the following departments and agencies this week:

Also, in addition to losing more money, Fannie Mae and Freddie Mac lose their inspector general.

Government Housing Adventures

The Wall Street Journal is reporting that Fannie Mae and Freddie Mac, which have already consumed $112 billion in taxpayer bailouts, may have additional losses if they can’t recoup claims from struggling private mortgage insurers.

From the Journal:

Fannie Mae has about $109.5 billion of mortgage-insurance coverage in force, which represents 4 percent of all single-family home loans it owns or guarantees. Freddie Mac had $63.4 billion in mortgage insurance and $12.2 billion in bond insurance. Private mortgage insurance is required for any home loan with less than a 20 percent down payment, and the policies typically cover 12 percent to 35 percent of losses in the event of a default, according to HSH Associates, a financial publisher. Mortgage insurers have been forced to pay up as loan defaults escalate.

Escalating loan defaults are also likely to bite taxpayers through the Federal Housing Administration, which covers 100 percent of losses. The FHA is in deep trouble:

The reduction in private insurance coverage has contributed to the rise in the volume of loans backed by the Federal Housing Administration, a government mortgage insurer that backs loans with as little as 3.5 percent down payments. It could be required to ask for a federal subsidy for the first time in its 75-year history if the housing market deteriorates further.

Who is looking out for taxpayers here?

Ryan Grim at Huffington Post reports that the Federal Housing Finance Agency, which is in charge of Fannie and Freddie, has used a legal technicality to rid itself of its inspector general:

There is no independent auditor overseeing the federal agency responsible for some $6 trillion in home mortgages, because the Department of Justice’s Office of Legal Counsel ruled that the agency’s inspector general didn’t have authority to operate, according to internal memos obtained by the Huffington Post. The ruling came in response to a request from the Federal Housing Finance Agency itself — which means that a federal agency essentially succeeded in getting rid of its own inspector general.

The timing is curious:

Fannie and Freddie are burning through cash at a staggering rate. Fannie reported a loss of $18.9 billion in the third quarter of 2009, four billion more than it lost in the second quarter. FHFA requested $15 billion from Treasury to plug the hole. What’s it spending money on? “The company continued to concentrate on preventing foreclosures and providing liquidity to the mortgage market during the third quarter of 2009, with much of our effort focused on the Making Home Affordable Program,” boasts the press release accompanying the announcement of the massive loss. “As of September 30, 2009, approximately 189,000 Fannie Mae loans were in a trial period or a completed modification under the Home Affordable Modification Program.” Those are the precise programs that Kelley was looking into when his own agency shut him down.

See here for essays on the problems associated with the federal government’s housing market interventions. Also check out Johan Norberg’s book, Financial Fiasco: How America’s Infatuation with Homeownership and Easy Money Created the Economic Crisis.