The authors of a study just released by the University of
North Carolina's Center for Community Capital suggest that the current condition
of the Federal Housing Administration's (FHA) finances is not as important as
the public purpose of the agency.
In Sustaining and
Expanding the Market: The Public Purpose of the Federal Housing Administration,
authors, Roberto G. Quercia and Kevin A. Park find three essential benefits
that FHA has historically provided to the U.S. housing markets; regional and
countercyclical stabilization, overcoming household wealth constraints, and
providing product innovation and standardization.
The private sector cannot maintain the mortgage credit
through economic downturns the way the public sector can. FHA and private mortgage insurance (PMI) have
the same purpose but technical differences that set them apart, especially the
fact that FHA is backed by the full faith and credit of the federal government.
PMI companies can and do become insolvent, file for
bankruptcy or are seized by regulators.
Even those that remain solvent must maintain acceptable levels of
capital. While FHA is currently experiencing
problems with its capital ratio, it is not illiquid and does not face capital
constraints. The government guarantee
insures that investors will still value FHA's insurance.
Resiliency is especially important for housing finance
because of its susceptibility to periods of boom and bust and because of the
circular nature of value. The value of property
which serves as collateral for credit is itself dependent on the availability
of credit. Price declines are
particularly destabilizing because American homeowners are leveraged and
mortgage debt will deepen housing downturns when homeowners are unable to refinance
to a lower interest rate or move into a new house, lowering market
liquidity. A drop in home equity
increases the risk of foreclosure and any foreclosure further depresses the
value of nearby homes.
management has difficulty with such systematic phenomena, where probabilities
are not independent but correlated. In contrast, public insurance is extremely
capable of diversifying risk across time.
It is easy to see that FHA has a countercyclical role to
that of PMI. Between 1990 and 2003, PMI accounted for roughly 12.6% of the entire
mortgage market by dollar volume and FHA just 6.7%. Then subprime lenders with high loan-to-value
ratios and subordinate "piggy back" loans stole their market share. As the housing market collapsed, private
mortgage insurance briefly rallied, but losses constrained its ability to write
new business. Since the beginning of 2009, private mortgage insurance has
accounted for less than five percent of the market while FHA has accounted for
FHA's is also countercyclical geographically. Private mortgage insurers implemented
"distressed area" policies, refusing to insure over 90 percent LTV loans in
some regions. FHA does not vary its
insurance premiums by region, automatically stabilizing distressed areas.
Between 2006 and 2009 FHA's market share of owner‐occupied
home purchase mortgages increased most in metropolitan areas that suffered the
largest decrease in house prices. Though
FHA typically had a very minor role in those markets during the run‐up,
these were the markets most severely cut off from conventional credit when the
crisis hit, and therefore most benefited by FHA's revival. FHA has always stepped in when and where
private lenders have retreated, preventing a downward spiral of house prices
and a reduction in credit availability.
A second purpose of FHA has been to serve borrowers and
neighborhoods poorly served by the private sector. While subprime mortgage
lenders targeted these individuals and regions with disastrous results, FHA has
proven capable of supporting sustainable lending to them.
Despite higher defaults rates common in loans with high LTV
ratios, FHA has lowered its down payment requirements over the years from 20
percent to 5 percent while maintaining a relatively modest rate of claims. This
is particularly important for first time homebuyers who accounted for 75
percent of all FHA endorsements in 201. FHA
lending served 41percent of all first time homebuyers. Since the subprime bubble burst FHA has
accounted for 61 percent of purchase mortgages for Hispanic and black borrowers
and these loans have been more sustainable than products in the conventional
The third essential role of FHA over the years has been to
test and standardize new types of mortgages when the private sector is not
willing or able. Many mortgage products
now called "traditional" were pioneered by FHA.
Before the Great Depression, most mortgages were short‐term,
interest‐only loans that had to be continually refinanced. FHA popularized loans that are fully
amortizing and with first 20-year and then 30-year terms, which reduced the
required monthly payments and increased the acceptable LTV. Fully underwritten 30‐year fixed‐rate
mortgages have accounted for three‐fourths of FHA endorsements by
volume since FY2000 and FHA‐insured mortgages have performed
significantly better than conventional subprime mortgages through the Great
The success of FHA led to the rebirth of a private mortgage
insurance industry in 1957 and revolutionized the secondary mortgage market through
Government National Mortgage Association ("Ginnie Mae") guaranties. The experiences of FHA‐insured
mortgages also helped inform the development of credit scoring and automatic
FHA's Mutual Mortgage Insurance Fund has been self‐sustaining
through borrower fees for 80 years. These premiums flow into a financing
account equal to projected costs and a capital reserve account for any remaining
funds. The two accounts have over $30 billion in capital resources, which,
given the rate of losses of the last four quarters, is enough capital to
continue paying claims for the next seven to ten years.
Unfortunately, not all of FHA's innovations have proven
down payment assistance programs artificially inflated sales prices and loan
amounts and caused high rates of default and substantial Fund losses. HUD attempted to prohibit these loans many
times, but was prevented by legal and political obstacles until 2008.
The National Affordable Housing Act mandates that the Fund
maintain at least a two percent capital ratio. As recently as FY2007, the Fund had a capital
ratio of 6.4, but in the last five years, the economic value of "forward" loans
(which excludes so-called reverse mortgages or HECMs) endorsed by FHA has
fallen by almost $35 billion. At the same time, FHA more than tripled its level
of insurance‐in‐ force, from $332 billion to over
$1.1 trillion. The simultaneous decrease in the denominator and the increase in
the numerator has caused the capital ratio to fall to under 0.1% in FY2011 and
ultimately to a negative 1.2% in FY2012.
As of the latest, FY2012 actuarial review, projected losses
on loans (excluding HECMs) are expected to eventually exceed projected revenues
and current capital resources by nearly $13.5 billion. HUD's 2012 report to
Congress notes these losses exceed those projected last year for three reasons:
a lower house price appreciation forecast (‐$10.5 billion); the continued
decline in interest rates (‐$8 billion); and a refinement in methodology
A negative economic value requires FHA to supplement its
capital with funds from the U.S. Treasury, an option that was not available in
the early 1990s when the fund also had a negative economic value. In that period the Fund was able to grow out
of its negative position by reforming its premium structure and endorsing new
books of business. The Fund may again grow out of its current predicament
without exhausting its capital resources.
The Fund has $30 billion in capital resources and the
actuarial analysis estimates there is only a five percent chance these
resources will be exhausted in the next seven years, partially due to its highly
profitable new books of business. Until
the capital resources are exhausted, any Treasury draw would simply be used to
stock the financing account, which is held in Treasury bonds.
The authors stress that financial calculations fail to
account for FHAs value to the broader economy-its true economic value. The expectation that the MMI Fund should
operate through a "hundred‐year flood" like a private company
ignores its public purpose. In
conducting the first independent actuarial study of the fund in 1989 Price
Waterhouse considered a "Great Depression" scenario but argued "the social
purpose of the Fund is such that it should not be expected to withstand such a
calamity" Instead, FHA is intended to use the full faith and credit of the
federal government to stabilize the housing market even if it means temporary
By continuing to finance mortgages even as house prices fell
and unemployment rose, FHA fulfilled its duty to step in when and where the
private market fails. Moody's Analytics
estimates that, if FHA had refused to stop insuring new mortgages in October of
2010, by the end of 2011 house prices would have fallen another 25%, new and
existing home sales would have fallen an additional 40%, and new home construction
would have dropped 60%. This would have
resulting in another two percent contraction of the economy, the loss of
another three million jobs, and an unemployment rate of 12 percent. This would have increased FHA losses as well
as that of PMI companies, GSEs, lenders, investors, and American Households.
Those who will decide how FHA should be structured going
forward should bear in mind how FHA has fulfilled its public purpose over the
past 80 years and mindful of the agency's challenges to fulfilling that purpose.
FHA should be empowered to protect communities from steering
and abuses by lenders and given greater flexibility and resources to keep step
with the market, particularly in the areas of risk and loss management. The
agency also faces the on‐going risk of adverse selection
from private sector insurers and investors. Policymakers have an extraordinary
opportunity to address such fundamental issues as they seek to shape a more
effective and resilient FHA for the future.
It may be tempting to reassess FHA's role based on its
current fiscal predicament and while that is concerning further major pricing
and underwriting changes beyond those already made or underway may not be
necessary to restore FHA's financial cushion and improve the value of recent
Right now an active FHA insurance program is still critical
for supporting the fragile housing recovery. FHA's current elevated market share merely indicates
the weakness in the private conventional mortgage market. In fact FHA's market share has already
decreased substantially from the height of the housing crisis and an over‐correction
may actually hinder the process of recapitalizing the MMI Fund.
The massive portfolios and guarantees of the GSEs are
scheduled to be gradually reduced without any clear sense of what will replace
them in the secondary market and definitions for Dodd-Frank Qualified
Residential Mortgages are not set. A
strict standard would limit the conventional lenders' ability to serve the
entire market so either FHA must be able to do so or else the housing market
must be prepared for a likely drastic reduction in the supply of mortgage
Even when conventional mortgage lending does return, FHA will
remain critical to the long‐term health of the housing market
which future demand is likely to come from traditionally underserved populations. This is the very type of borrower that FHA
has served successfully over the decades.
The purpose of FHA is to fill in the gaps in the
availability of mortgage credit and its purpose is likely to become even more
relevant as a result of the restructuring of housing finance system and of the
likely demographic changes that will characterize America's mortgage demand.
The actuarial soundness of the Mutual Mortgage Insurance Fund is only an
indication that FHA fulfills its public purpose efficiently. A full measure of
that efficiency must take into account the whole range of benefits derived from
the fulfillment of its public purpose.