Earlier this week, I testified again on ways to restructure the Federal Housing Administration (FHA). At the hearing, some witnesses and Members posited an idealized view of the FHA and then demanded legislation to achieve it. In their view, FHA can pose no risk to taxpayers, offer borrowers loans with virtually no down payments and fill the needs of low-income buyers by keeping the current loan limits (now well above median house prices). This might be nice, but it can’t be done. In housing policy – like all others – trade-offs aren’t always compromises. Often, they are essential controls to ensure that well-defined goals suitable for government intervention are achieved in a meaningful way at reasonable risk.

The FHA debate is a lot like that over Fannie and Freddie: everyone seems to agree on a goal – something better than what went before and led to the crisis – but then debate promptly dissolves into recrimination or insistence on one piece of the policy without regard for its impact on all the others. It’s simply impossible to come up with a government mortgage guarantee that poses no taxpayer risk at the same time it provides a 100 percent guarantee for lenders and investors. It’s simply impossible to ensure that borrowers are protected if the lender takes no risk when it gets the fees attendant to FHA loans. It’s difficult for borrowers to enjoy sustainable home ownership if they are first time or low-income ones and put virtually nothing down and then suffer a job loss or other problem as their house falls in value. And, finally, it’s simply impossible for a government program truly to focus on low- and moderate-income buyers if it can back loans up to $271,000 around the country while the national median existing house price is $160,000. Add the $729,750 top FHA limit, and the challenge of making this make sense for FHA’s mission – low-income borrowers – gets still more formidable.

The only way we see to make FHA make sense is to refocus it, for example by giving on the federal guarantee to get better treatment for truly low-income and first-time home buyers. Right now, lenders have no “skin in the FHA game” – instead, it’s all taxpayer epidermis. With some lender/investor risk – think VA loans where the federal guarantee starts at 50% for small loans and then falls to 25% as the loan amount increases – lenders would take more care and, thus, borrowers would get better protection. Give borrowers better protection, and then they could also get a zero down payment loan. Then, the borrower’s risk is offset by lender prudence, especially if buttressed by potential lender loss through a partial federal guarantee.

Hard, yes. But, what’s the alternative? Keep FHA as is? If so, then it will gradually take over low down-payment U.S. housing finance and we’ll have de facto nationalization even as policy-makers debate the prospect of GSE privatization. If FHA is the principal source of high-dollar, low-downpayment, no-risk money for mortgage finance, guess what happens.