Haunted Housing Policy

March 31, 1998 • Commentary
This article originally appeared in the Washington Times.

Bill Clinton pontificates continuously about equity and “fairness.” He routinely attacks Republican policies for allegedly benefiting the wealthy. But one of the major housing initiatives in his budget would expand Federal Housing Administration mortgage subsidies to mostly higher‐​income homebuyers. The plan would nearly triple the FHA loan limit in most housing markets from $86,000 to $227,000.

How many moderate‐​income first‐​time homebuyers can afford a $200,000 plus mortgage? To afford a home at that price, the buyer would typically be required to have an income of $80,000 or more. That’s double the median family income.

It gets worse. The Clinton budget office would score the premiums raised from FHA mortgage insurance subsidies as new tax revenues, thus lowering the reported budget deficit by $200 million and helping pay for new spending programs. This latest gimmick gives budgetary blue smoke and mirrors a bad name. Of course, since the billions of dollars in added liabilities from FHA home mortgage guarantees are costs that won’t show up until after the president’s term expires, this budget ploy is ingenious politics.

But it’s reckless fiscal policy. If Congress approves the scheme, it could wind up costing taxpayers tens of billions of

dollars if and when the housing market softens and defaults start increasing. The FHA already holds a Mount Everest‐​sized $360 billion in loan guarantees in its portfolio — a liability that would dramatically rise if loan limits were lifted.

The FHA’s loan guarantees have required huge taxpayer bailouts in the past. In the housing recession of 1988, the FHA lost a record $1.4 billion. Today the potential taxpayer liability is almost three times as large as it was then. Yes, it is true that the FHA is making a paper profit these days, meaning that its premium income exceeds its payments for defaults. Just remember, the Federal Savings and Loan Insurance Corp. was making a hefty profit for taxpayers for many years until the bubble burst in 1989 and taxpayers were forced to pay for a $150 billion bailout of the savings‐​and‐​loans.

If the FHA is losing market share to the PMIs and to high‐​down‐​payment homes that don’t require mortgage insurance, Congress should conclude that this 60‐​year‐​old agency is becoming obsolete. Do we worry about the Postal Services “losing market share” to Federal Express or to e‐​mail?

In recent years the delinquency rate on FHA loans has soared to more than 8 percent — triple the delinquency rate on conventional loans. The publication Inside Mortgage Finance reported in February that “FHA mortgage defaults and property acquisitions have jumped dramatically [to $4.25 billion] over the past year.” This meteoric rise in claims occurred in the midst of a roaring housing market.

If the FHA is experiencing soaring defaults in a bullish housing market, its losses during an economic slowdown could total tens of billions of dollars. Congress should recognize that, given the FHA’s shaky finances, fiscal prudence requires contracting the FHA’s insurance pool.

So why does the administration want to expand it? Amazingly, Housing Secretary Andrew Cuomo has stated that the FHA needs to move into the higher end of the housing market in order to “maintain its market share” of the mortgage insurance business. This government agency competes against a financially healthy private mortgage insurance industry. More than half of the low‐​end mortgage insurance market is now served by private mortgage insurers (PMIs). The FHA is engaged in a mission of self‐​preservation.

Since the FHA was created by FDR during the Depression era, its mission has always been to focus solely on lower‐​income homebuyers who might not have access to private insurance. If the FHA is losing market share to the PMIs and to high‐​down‐​payment homes that don’t require mortgage insurance, Congress should conclude that this 60‐​year‐​old agency is becoming obsolete. Do we worry about the Postal Services “losing market share” to Federal Express or to e‐​mail?

Proponents of raising the loan limits for higher‐​income buyers believe that this policy will improve the pool of loans held by the FHA, because higher‐​income buyers are less likely to default on their mortgages. Of course, under this theory, there should be no loan limit at all. Taxpayers should be providing subsidized mortgage insurance to Bill Gates, George Soros and Madonna when they build $10 million mansions.

In any case, the proposition that expanding the FHA to higher value loans will reduce delinquency and loss rates is specious. The overwhelming evidence shows that the primary predictor of mortgage default is not the income of the homebuyer or the size of the loan but the size of the down payment relative to the loan amount. A high‐​down‐​payment mortgage to a low‐​income family is less likely to be defaulted on than a low‐​down‐​payment mortgage to a high‐​income family. Bad news: in the 1990s the average down payment on FHA‐​insured loans has been falling and is now less than 5 percent on average.

So who will be the primary beneficiaries of an expanded FHA? Advocates of the poor aren’t engaged in a lobbying blitzkrieg on Capitol Hill. The mortgage bankers and the realtors are. The mortgage banking industry figures to make a fortune off an expanded FHA because they make more money on FHA‐​insured homes than on conventional mortgages. The FHA is one of Uncle Sam’s largest dispensers of corporate welfare dollars.

The White House’s indefensible FHA proposal should be dead on arrival in Congress. Yet congressional Republicans are flirting with the scheme themselves to please the well‐​financed housing lobby.

Just three years ago House Republicans were advancing sound legislation to privatize the FHA and get the government out of the mortgage insurance business. That makes a lot more sense than expanding FHA subsidies to new constituencies that don’t need — or deserve — it.

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