Reports of FHA's Demise Greatly Exaggerated
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You hear it all the time in conversation: The federal government has merely transferred the subprime problem from the GSEs to FHA. People ask, "How can the government in good conscience be making mortgages to people and only require 3 percent downpayments, especially in today's economic environment with rampant job losses?"
Let's not forget that these are the very economic conditions under which FHA was designed to operate. The whole idea behind the program was that the government would step into the mortgage market when private lenders weren't willing to lend, which turns out to be a pretty good description of the situation today. FHA insured half the mortgages made to first-time buyers in the second quarter of this year. There may not have been a housing recovery without FHA.
As an annual report to Congress by its auditors makes clear, FHA was only around to make these loans because it never loosened its underwriting requirements to participate in no-documentation loans. It never insured exotic loans. It doesn't permit piggy-back loans that allowed people to fund downpayments with second mortgages. Moreover, the agency has been steadily increasing the average FICO scores of borrowers; they have gone from 633 two years ago to 693 today.
The one thing it was forced by Congress to do, over agency objections, was to allow seller-funded downpayments, where builders and other sellers could in effect give borrowers downpayments by giving it to a charity first. This practice, it turns out, has cost the agency dearly. Defaults on these kinds of loans are running at two and three times the normal rate.
If it weren't for seller-funded mortgages, which were finally abolished last year, FHA's excess reserves would be above the 2 percent requirement set by Congress. As it is, they have dipped below the threshold.
The auditors run complicated actuarial analyses to test the adequacy of FHA's reserves under various economic conditions. In a base case scenario, with a 14 percent peak-to-trough drop in house prices nationally, as measured by FHFA, they figure that FHA only has $3.6 billion in excess reserves, "a thin [0.53%] margin for a $685 billion portfolio. However, it should be remembered that this is after reserving for expected net outlays over a 30-year period."
FHA Commissioner David Stevens, speaking at the National Association of Realtors annual meeting last week, said that concerns that the agency is headed for the same fate that befell Fannie Mae and Freddie Mac are unwarranted. "Nothing could be further from the truth," said Stevens, who went on to remark that FHA is the only participant in home financing services that hasn't needed a bailout.
FHA's total capital reserves, which it needs to protect against losses, have actually grown this year, from $27.2 billion to $30.7 billion, largely due to upfront premiums it collected on a record volume of new insurance business in 2009. Moreover, the loans it has made recently, with tighter underwriting requirements, are likely to have lower default rates than the ones made in recent years.
That said, the agency faces some significant challenges. First, because it has actually been making loans in recent years, it has a higher rate of delinquencies and foreclosures on its portfolio than private lenders. Specifically, about 17 percent of FHA borrowers are at least one payment behind, compared to 13 percent for all loans, according to the Mortgage Bankers Association. On the other hand, early defaults on its loans have been declining for two years, due to tighter underwriting.
FHA has responded to this challenge by implementing real-time monitoring of its portfolio performance and delinquency, default rates, and economic conditions. It has also tightened rules for appraisals.
"Without FHA," Stevens said, "there would be no (housing) market, and this economy's recovery would be significantly slower."