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Fixing Mortgage Finance: What to Do with the Federal Housing Administration?
Abstract
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 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.
... First, the loans that were insured during the height of the housing boom -while a fraction of the total book-of-businesswere to especially weak borrowers and had little time to benefit from house price appreciation. Second, as the FHA's market share expanded during the housing bust, many of its new loans to creditworthy borrowers performed poorly owing to their typically very low down payments, coupled with massive 27 Calabria (2012) provides an alternative view about the future of the FHA. 13 house price declines, resulting in a large fraction of mortgages with negative equity. 29 As a result of these developments, the FHA's "mortgage mutual insurance fund" has fallen to 0.24 percent -well below the statutorily mandated floor of 2.00 percent. ...
This paper seeks to contribute to the U.S. housing finance reform conversation by providing a critical assessment of the various types of policy proposals that have been offered. There appears to be a broad consensus to maintain explicit government guarantees for certain narrowly defined borrower populations, such as Federal Housing Administration insurance guarantees for low- and moderate-income and first-time homebuyers. However, the expected role of the federal government in the broader housing finance system is in dispute. The expected role ranges from no role to insuring against only extreme or tail events to insuring against all losses. However, most proposals agree that any public insurance be priced and available only for loans meeting specified criteria to limit taxpayer exposure.
The 1980s was a bad decade for FHA's Mutual Mortgage Insurance (MMI) program, the mainstay of FHA's single family mortgage insurance. While the MMI Fund is required by statute to be actuarially sound, the Fund lost close to $6 billion dollars, and its economic value declined from 5.3 percent of insurance-in-force to under one percent. This study documents the decline in the soundness of the MMI Fund in the 1980s and describes the legislation enacted in October 1990 to shore up the Fund. Copyright 1992 by Kluwer Academic Publishers
The recent financial crisis was characterized by losses in nearly every type of investment vehicle. Yet no product has attracted as much attention as the subprime mortgage.What is generally agreed is that subprime mortgages disproportionately contributed both to the severity of the crisis and to the size of losses imposed upon the taxpayer. What remains in dispute is the role of government — specifically, that of Fannie Mae and Freddie Mac — in expanding the availability of subprime mortgage credit.Changes in the mortgage market, resulting largely from misguided monetary policy, drove a frenzy of refinancing activity in 2003. When that origination boom died out, mortgage industry participants looked elsewhere for profits. Fannie and Freddie, among others, found those illusionary profits in lowering credit quality.Foremost among the government-sponsored enterprises' deleterious activities was their vast direct purchases of loans that can only be characterized as subprime. Under reasonable definitions of subprime, almost 30 percent of Fannie and Freddie direct purchases could be considered subprime.The government-sponsored enterprises were also the largest single investor in subprime privatelabel mortgage-backed securities. During the height of the housing bubble, almost 40 percent of newly issued private-label subprime securities were purchased by Fannie Mae and Freddie Mac.In order to protect both the taxpayer and our broader economy, Fannie Mae and Freddie Mac should be abolished, along with other policies that transfer the risk of mortgage default from the lender to the taxpayer.
We analyze originations of mortgages guaranteed by the Federal Housing Administration (FHA) and of subprime mortgages—loans
that dominate the non-prime mortgage market for riskier borrowers. Using home purchase and refinance loans data for 2005,
we estimate that a sizeable number of borrowers who got subprime loans would have qualified for FHA loans, implying a potential
net flow of borrowers from subprime to FHA, especially for refinance loans at a rate of about 30%. Also, consistent with the
FHA’s modernization proposal to increase its loan limits, we find that increasing the limits on FHA loans could help to attract
borrowers, mostly of home purchase loans, who are likely to be constrained by the lower-priced house limits. Our findings
are generally in line with the recent increased flow of mortgages to FHA, and suggest that FHA loans could be the answer to
the current subprime lending crisis.
KeywordsSubprime lending–Mortgage originations–Home purchase–Refinance–FHA loan limits
This article uses a unique demonstration program to examine the interaction of CRA-related lending with subprime and FHA lending
activity. Specifically, the empirical analysis identifies the extent to which the origination of a CRA mortgage substitutes
for FHA and subprime originations during the period 1998–2006. The results suggest that in the years prior to the expansion
of the subprime market (1998–2001), the origination of CRA loans carried a small substitution effect with respect to FHA originations,
with little to no impact on subprime originations. Conversely, during the years of the subprime industry’s growth (2002–2006),
CRA originations substituted at a much higher rate for high-cost originations. These findings are suggestive about the dynamic
role of community reinvestment lending within the changing context of the broader mortgage market. To the extent that CRA
originations carry lower foreclosure risk than many subprime products, they also carry implications for the extent of neighborhood
externalities in the wake of the subprime foreclosure crisis.
KeywordCommunity reinvestment act–Mortgage origination
We examine foreclosures on FHA single-family mortgages insured during the 1975-87 period. The importance of the market value of borrower equity and national house price dispersion support much earlier work emphasizing the key role of negative equity in triggering default. The lower is "mean" market-value equity, and the greater is dispersion, the greater is the fraction of borrowers likely to have negative equity. The unemployment rate and the book value of borrower equity are also shown to be significant determinants of default. Unemployment is one of those events that can force borrowers to move. The moving decision increases the likelihood of default because moving costs no longer deter default, and the costs of selling the house reduce the effective equity in the house. The book value of equity is relevant to this decision because it is what the sellers receive if they move without defaulting. Not only are both of these variables significant determinants of default, but the smaller is book equity, the greater is employment impact (with large book equity, unemployment should not matter because selling the house is preferred to default). Copyright American Real Estate and Urban Economics Association.
This paper investigates the relationship between short-term interest rates and bank risk. Using a unique database that includes quarterly balance sheet information for listed banks operating in the European Union and the United States in the last decade, we find evidence that unusually low interest rates over an extended period of time contributed to an increase in banks' risk. This result holds for a wide range of measures of risk, as well as macroeconomic and institutional controls.
History of Mortgage Finance with an Emphasis on Mortgage Insurance
For a general history, see Thomas Herzog,
"History of Mortgage Finance with an Emphasis on
Mortgage Insurance," Society of Actuaries, 2009.
The Creation of Homeownership: How New Deal Changes in Banking Regulation Simultaneously Made Homeownership Accessible to Whites and out of Reach for Blacks
For the FHA's role in redlining, see John Kimble, "Insuring Inequality: The Role of the Federal
Housing Administration in the Urban Ghettoization of African Americans," Law and Social Inquiry
32, no. 2 (June 2007), 399-434. See also Adam Gordon, "The Creation of Homeownership: How New
Deal Changes in Banking Regulation Simultaneously Made Homeownership Accessible to Whites
and out of Reach for Blacks," Yale Law Journal
115, no. 1 (October 2005): 186-226. For an alternate view of redlining more generally, see Andrew
Holmes and Paul Horvitz, "Mortgage Redlining:
Race, Risk, and Demand," Journal of Finance 49, no. 1
(1994): 81-99.
- Xudong An
- Raphael Bostic
Xudong An and Raphael Bostic, "GSE Activity, FHA Feedback, and Implications for the Efficacy of the Affordable Housing Goals," Journal of
Real Estate Economics and Finance 36, no. 2 (2008):
207-31.
For historical house price series, see Robert Shiller's estimates
- Aragon
For historical house price series, see Robert
Shiller's estimates, http://www.econ.yale.edu/s
hiller/data/Fig2-1.xls. See also Deigo Aragon et
al., "Reassessing FHA Risk," NBER Working Paper
15802, March 2010.
Accounting for FHA's Single-Family Mortgage Insurance Program on a Fair-Value Basis
- Congressional Budget Office
Congressional Budget Office, "Accounting for
FHA's Single-Family Mortgage Insurance Program
on a Fair-Value Basis," May 18, 2011.
23. Testimony of Carol Galante, Acting FHA
Commissioner, before the United States House
of Representatives, Subcommittee on Insurance,
Housing and Community Opportunity, September 8, 2011.
Homeownership: Potential Effects of Reducing FHA's Insurance Coverage for Home Mortgages
- Ken Testimony
- Donohue
Testimony of Ken Donohue, Inspector General, HUD, before the United States Senate Committee on Banking, Housing and Urban Affairs,
July 18, 2007.
26. United States Government Accountability Office, "Homeownership: Potential Effects of Reducing
FHA's Insurance Coverage for Home Mortgages."
27. Albert Monroe, "How the Federal Housing
Administration Affects Homeownership," Harvard
University, Joint Center for Housing Studies, 2001.
Similar findings of a small FHA impact on homeownership are found in Zeynep Onder
- John L Goodman
- Joseph B Nichols
John L. Goodman, Jr., and Joseph B. Nichols,
"Does FHA Increase Home Ownership or Just Accelerate It?" Journal of Housing Economics 6, no. 2
(1997): 184-202. Similar findings of a small FHA
impact on homeownership are found in Zeynep
Onder, "Homeownership and FHA Mortgage
Activity in Neighborhoods and Metropolitan Areas," Journal of Housing Economics 11, no. 2 (2002):
152-81.
Working Paper 2011-019A, Federal Reserve Bank of St
- Juan Carlos Hatchondo
- Leonardo Martinez
- Juan Sanchez
Juan Carlos Hatchondo, Leonardo Martinez,
and Juan Sanchez, "Mortgage Defaults," Working
Paper 2011-019A, Federal Reserve Bank of St. Louis, August 2011, http://research.stlouisfed.org/wp/
more/2011-019.
For regressive impact see Karsten Jeske, Dirk Krueger, and Kurt Mitman, Housing and the Macroeconomy: The Role of Bailout Guarantees for Government Sponsored Enterprises, NBER Working Paper 17537
- John M Quigley
- Robert Van Order
United States Bureau of the Census, Department of Commerce, Who Can Afford to Buy a House?
various years, http://www.census.gov/hhes/www/
housing/hsgaffrd/hsgaffrd.html.
31. On the costs of low down payment subsidies, see
Yongheng Deng, John M. Quigley, and Robert Van
Order, "Mortgage Default and Low Downpayment
Loans: The Costs of Public Subsidy," Regional Science
and Urban Economics 26, no. 3-4 (1996): 263-85.
32. For regressive impact see Karsten Jeske, Dirk
Krueger, and Kurt Mitman, Housing and the Macroeconomy: The Role of Bailout Guarantees for Government Sponsored Enterprises, NBER Working Paper 17537, October
2011, http://www.nber.org/papers/w17537.
33. For racial differences in benefits, see Onder.
An Exit Strategy for the
- Freddie Mac
- Fannie Mae
Freddie Mac and Fannie Mae: An Exit Strategy for the Taxpayer by Arnold
Kling (September 8, 2008)
A Fork in the Road: Obama, McCain, and Health Care by
A Fork in the Road: Obama, McCain, and Health Care by Michael Tanner
(July 29, 2008)
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