November 18, 2011

The Continued Strength of the FHA

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This week, HUD released its annual report to Congress on the financial status of the Federal Housing Administration (FHA) Mutual Mortgage Insurance (MMI) Fund.  The report demonstrates the long-term strength of the Fund while not shying away from the challenges it faces in the near-term due to ongoing stresses in the housing market.  While the independent actuary reports older books of business underwritten during the bubble years of 2000-2008 are expected to produce losses of more than $26 billion, it also finds that FHA has a very strong platform going forward, with insurance on loans booked since January 2009 posting an estimated net economic value of $18 billion. Indeed, the actuary reports that the Fund still retains positive capital, and that it should be able to rebuild capital to the statutory requirement of two percent of insurance-in-force very quickly once housing markets across the county exhibit sustained growth.

Notwithstanding findings of the independent actuary that the FHA MMI Fund retains positive capital four years into the worst housing crisis since the Great Depression, a report commissioned by the American Enterprise Institute (AEI) suggests that FHA both lacks an actuarially sound program and is in current need of a significant capital infusion.  I want to take this opportunity to refute some of the study’s most outrageous claims and set the record straight.

AEI says: “FHA is the ‘next housing bailout.’”

  • Not true.  According to the independent actuary, the MMI Fund capital balance remains positive and its programs are sound.
    • Higher Reserves. FHA’s total liquid assets are at their highest point ever, and $400 million higher than one year ago. Over the past three years, HUD has paid out a record $35 billion in claims while increasing its dedicated loss reserves by $20 billion. 
    • Buoyed by New Books of Business. Though the actuary predicts a record payout of claims in 2012, it also estimates that the new 2012 book of business will add $9 billion to the economic value of the Fund.
    • Closely Tied to Home Prices. Ultimately, the finances of the FHA insurance Fund are tied to home prices and prices have been weaker than expected in 2011. The actuarial estimates imply that home prices would have to fall another 4-to-5 percent in 2012 before FHA would require outside assistance.

AEI says:  “FHA has become a much riskier organization.”

  • Wrong – there is virtually no comparison between the older books of business and today’s, due, in part, to important policy changes and premium increases made by this Administration. 
    • Improved Borrower Quality. Where nearly half of FHA borrowers had credit scores below 620 in 2007, only 3% of FHA borrowers in 2010 and 2011 had credit scores under that threshold. 
    • Higher Volumes, But Also Higher Quality. While it is true that FHA volume has grown—representing about a third of the market in the absence of private capital—the 2009-2011 books (about 75% of FHA’s portfolio) are performing substantially better than are earlier books. The age-12-month seriously delinquent rate on loans in the FY2010 book was just over 1 percent, whereas it was over 6 percent in the 2007 and 2008 books.
    • …And Higher Premiums As Well.  This growth in volume has been accompanied by higher premium rates that have been increased three times under this Administration and are now at the highest levels in FHA history.
    • Reforms Have Kept FHA Finances Positive. The actuary reports that FHA would be “in the red” were it not for its reforms – many of which came in response to prior warnings of the independent actuary.

AEI says: “[As many as 1 million] high-risk loans [were] made to borrowers who did not make the required down payment entirely with their own funds.”

  • Completely false and irresponsible.  The AEI study attempts to argue that FHA borrowers monetized the “First-Time Homebuyer Tax Credit” to make down payments on loans they couldn’t otherwise afford – similar to the so-called “Seller-Funded Down Payments” Congress put an end to in 2008.  In fact:
    • Seven-in-Ten Made Down Payments Themselves. Of the 1 million first-time homebuyers that used FHA insurance during the 13 months the tax credit was used most heavily, more than 700,000 borrowers used their own funds to make the down payment – while another 277,000 received gifts from a relative.  Both have had to-date “failure” rates of less than 1 percent.
    • Very Few FHA Borrowers Borrowed Against the Tax Credit. During the 13 months when tax-credit induced home purchases were at their peak, only 38,000 FHA-insured home buyers used HUD-approved government funded “secondary financing” programs.  This represents less than 4 percent of FHA first-time homebuyers during that period; only 1.6 percent of those have gone to claim or are in foreclosure.   By contrast, almost ten times as many first-time homebuyers in the 2006-2008 books of business used “seller funded down payments” —over 335,000 homebuyers—and their two-year claim rate was 3 percent – twice that of loans with secondary financing from government agencies and more than four times that of loans where borrowers paid their own down payment from the same period.

AEI says: “The risk of future defaults, and the losses associated with them, is being systematically underestimated

  • This is misinformed, as the actuarial model is sensitive to economic conditions, initial down payment and borrower credit quality.  But here again, the actuarial report is quite blunt in its assessment of older books of business as well as the more recent streamline refinance portfolio.
    • High Expected Losses on Older High-Risk Loans. The actuary predicts as many as half of all low-FICO, high-LTV loans insured at the peak of the housing markets will ultimately result in loss for FHA. Indeed, they predict that more than 1 out of every 4 loans insured in 2007 alone will result in an insurance claim.
    • Higher Expected Losses for Streamline Refinance. While older books of business are weighing heavily on Fund finances, FHA’s highest risk since 2009 has been in the streamline refinance portfolio. The actuary has consistently predicted higher default losses from those loans than from fully-underwritten loans originated in the same time periods.  These warnings prompted HUD to take strong measures to substantially reduce that risk going forward.

There are several other “methodology” arguments made by AEI that are spurious – from arguing the actuary didn’t use unemployment rates as a factor determining default potential (home prices are historically a far more valuable indicator), to arguing that the actuary used a different (though widely respected) home price index.  And it completely ignores our reforms to credit policy, risk management, lender enforcement, and consumer protections, which collectively represent the most sweeping in FHA history.    

But perhaps the most telling omission isn’t any step we’ve taken at HUD – but rather the results we’ve gotten.  While reasonable people can disagree over predictions of what the future will hold, what isn’t in dispute is what FHA is doing right now.  According to our most recent quarterly report to Congress, endorsements in the 3rd Quarter added $1.7 billion in new funds to the capital reserve account, and the serious delinquency rate is well below year-earlier levels – this despite ongoing uncertainty in the housing market.

Put simply, while FHA’s future may be linked to the future of our housing market, FHA—representing a third of the market—is also essential to the recovery of our housing market.  Providing access to credit for homebuyers of all income ranges and in all communities, and stabilizing our housing market, has been FHA’s mission for nearly eight decades.  And the only prediction I’m willing to make is that it will continue to do so.

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