Briefing Paper No. 123

Fixing Mortgage Finance: What to Do with the Federal Housing Administration?

While Fannie Mae, Freddie Mac, and private subprime lenders have deservedly garnered the bulk of attention and blame for the mortgage crisis, other federal programs also distort our mortgage market and put taxpayers at risk of having to finance massive financial bailouts.

The most prominent of these risky agencies is the Federal Housing Administration (FHA). The FHA currently backs an activity portfolio of over $1 trillion. With an economic value of only $2.6 billion, representing a capital ratio of 0.24 percent, relatively small changes in the performance of the FHA’s portfolio could result in significant losses to the taxpayer. As the taxpayer is, by law, obligated for any losses above the FHA’s current capital reserves, these are not losses that can be avoided. Reasonably foreseeable changes to the FHA’s performance could easily cost the taxpayer tens of billions of dollars, surpassing the ultimate cost of the Troubled Asset Relief Program (TARP) bank bailouts.

To protect the taxpayer and the broader economy, the FHA should be scaled back immediately, and an emphasis should be placed on improving its credit quality. At the same time, the agency should be placed on a path to ultimately be eliminated, with its risk-taking being transferred back to the private sector.

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Mark Calabria is the director of financial regulation studies at the Cato Institute. He served on the staff of the U.S. Senate Committee on Banking, Housing and Urban Affairs and drafted significant portions of the FHA Modernization Act of 2008. He also served as deputy assistant secretary for regulatory affairs at the U.S. Department of Housing and Urban Development, where he oversaw FHA’s minimum property standards program.