As early as today, the Federal Housing Administration’s latest actuarial report will show it’s still on life-support, but not flat-lining. This will prevent the need for an FHA bail-out, but still demonstrates just how fragile FHA remains. With Fannie and Freddie now heading towards FHA’s jugular with new high loan-to-value mortgages, the government’s own housing guarantor faces an urgent dilemma. If it drops premiums to compete against the GSEs for high-quality borrowers, then it loses revenue and takes a lot of risk under-pricing its big book of high-risk mortgages. But, if it doesn’t drop premiums, then the GSEs will adversely select it for the good paper, ensuring FHA’s renewed tussle with the Grim Reaper. To survive, FHA needs high loan limits and high premiums; to compete, it needs high loan limits and low premiums for low-risk loans. To fulfill its mission, it needs a total makeover.
Why does FHA matter so much? First, with a book of about $1.1 trillion, it’s not exactly a minor contributor to taxpayer risk. Second, as the largest U.S. Government mortgage guarantor, it is meant to play a targeted policy role: supporting low- and moderate-income borrowers, especially first-time ones, not eligible for private-sector mortgages, including those purchased by Fannie and Freddie. For there to be affordable housing, there needs to be FHA.
However, FHA’s mission in recent years has morphed beyond recognition. In the mid-2000s, its then-commissioner decided to throw caution to the winds to garner market share. With private lenders gobbling up subprime mortgages as fast as they could, FHA decided to match them and then some. Because it was still adversely selected, it got the worst of the worst. When all this came crashing down, it was amid the rest of the housing market’s wreckage. With few direct government channels, FHA was nevertheless tapped as part of the rescue mission, giving a loan limit of as much as $729,750 and an array of other privileges. These actually exacerbated its problems in the early stage of the recovery –it now has not just a lot of left-over small foreclosures, but also lots of very big, very bad loans.
Which brings me to FinServ Chairman Hensarling. Little noticed in his 2013 PATH Act rewriting U.S. housing policy was a restructuring of the FHA. Among other things, it turned it into a government corporation, refocused it on lower-income and first-time borrowers, and permitted risk-sharing with private capital. Although FHA and HUD actually support aspects of the Hensarling approach, it quickly became embroiled with controversies over the rest of the PATH Act, which scuttled the GSEs in favor of fast-track private-label mortgage securitization.
Key to the attack against the Act were allegations that the bill eliminates the thirty-year, fixed-rate mortgage – a mortgage product Democrats and, in the Senate, Republicans called a cornerstone of middle-class America. Mr. Hensarling tried valiantly to defend his bill by pointing to the FHA provisions to show that borrowers who needed government help would get these favorable mortgages, but the bill collapsed in a whirl of partisan wrangling.
Which brings me back to what the next Congress will do. Rep. Hensarling is already firing a fusillade against the GSEs’ new 97s and he will surely take similar aim at any lowered FHA premiums. Even more challenging to the FHA – as well as Fannie and Freddie – is the new way the GOP will measure the cost of these housing-finance guarantees on the federal budget. A top priority is a shift to fair-value accounting, which we expect the Senate also quickly to adopt. This will make FHA, Fannie, and Freddie a lot more expensive in terms of measuring the deficit and, thus, a top-priority for a redo. Fix the housing agencies, reduce the deficit – or so it will go under fair value.
With this, the stage is set for action not just on FHA, but also housing finance more generally. Remember that Sen. Shelby is still licking his wounds from a failed reform package of his own when last he was Banking Chairman, and the roster is complete for near-term action on a GOP bill that rewrites all the rules of this very important road.