The Federal Housing Administration (FHA) is in deep trouble. After tripling the size of its insurance to $1 trillion in the past four years, it’s now balancing an extremely leveraged portfolio with a dangerously small cash cushion. Unless the economy makes a swift recovery, my research shows that FHA will need a massive taxpayer bailout—between $50 and $100 billion. If the economy turns down for any reason, even more funds would be needed.
Here are the key findings from my report, “Is FHA the Next Housing Bailout?”
FHA has become much bigger and riskier: FHA insures borrowers who typically make less than a 5 percent down payment on their home purchase. Its expansion occurred during a time of falling house prices and rising unemployment. Well over half of its insurance portfolio is based on mortgages taken out by borrowers with negative equity in their homes.
FHA is seriously undercapitalized for the risks it is taking on: FHA has not increased its reserves proportionally and has violated its capital reserve guidelines established by the National Affordable Housing Act of 1990 for the past two years.
FHA systematically overestimates the value of its main insurance fund, the Mutual Mortgage Insurance Fund: In doing so, it makes four types of mistakes that underestimate future losses by at least $50 billion.
1. It has simply assumed that unobserved high credit risk on post-2006 insurance pools (i.e., those after the housing bust began) will disappear by 2014. No theory or evidence is presented to support this conclusion, which results in 50 percent drops in default rates.
2. It has incorrectly modeled streamline refinancings as eliminating future default risk from its insurance pool. The only way a refinancing does so is if the loan is refinanced by another loan not insured by FHA.
3. It has failed to recognize the risk associated with borrowers who used the recent $8,000 tax credit to fund their down payments. Past data indicate that borrowers who do not fund down payments out of their own resources default at rates up to three times higher than other borrowers. FHA may have insured one million or more of them.
4. It has underestimated the amount of negative equity on the homes backing its mortgage insurance portfolio. FHA uses a price index based on sales of homes that were conventionally financed. FHA’s borrowers put down much less equity and buy cheaper and lower-quality homes that tend to appreciate at lower-than-average rates.
Given that FHA’s total liquid capital resources are only about $30 billion, its main insurance fund is effectively broke.
Reevaluating housing policy. The high costs of FHA’s expansion beg the question of how far the government should attempt to increase homeownership rates. This is more than a question of costs to taxpayers. We should also consider whether households truly are better off is they have to make 30-to-1 leveraged bets on a home, and have to use their lifetime savings to do so.