Follies of the FHA
Another subprime idea.


John Berlau

“How could they have been so stupid?” That’s the million-dollar question being asked as mortgage defaults have increased on loans that carried much more risk then lenders, borrowers, and investors anticipated.

But this question may be overtaken by one with a multibillion -dollar price tag years from now. That may be, “How could our elected representatives have been so stupid?” Despite the valiant efforts of fiscal hawks such as Sen. Tom Coburn (R., Okla.), and several House members in the conservative Republican Study Committee, both bodies of Congress have passed bills to put taxpayers on the hook for more risky loans from the Federal Housing Administration (FHA). And the Bush administration is supporting these bills, despite the fact that this government agency already has a subprime record of subsidizing loans.

Bush has, in fact, made the FHA — an agency created during Franklin D. Roosevelt’s “New Deal” in 1934 to help low and middle-income borrowers obtain housing — a centerpiece of the mortgage “rescue” plan announced this month by Treasury Secretary Henry Paulson. The plan — which would freeze introductory rates of adjustable-rate loans for five years for some borrowers, and which an NR editorial castigated for “rewarding irresponsible lending and borrowing” and potentially doing “enormous damage to the reputation of securities backed by American debt” — hinges on subprime borrowers refinancing into an FHA fixed-rate loan as the rate freeze “thaws.” That’s why, in his speech announcing the plan, Paulson also called on Congress to pass legislation to “help refinance another estimated 200,000 families into FHA-insured loans.”

The FHA insures a mortgage from default up to a limit of about $365,000. This greatly reduces a bank’s risk from making these loans, but can also create a substantial “moral hazard” because of the taxpayer backing.

Because of proliferating mortgage options and soaring housing prices, FHA-backed loans declined as a share of the mortgage market over the past decade. But now with current mortgage woes, both the Bush administration and Democratic leaders support expanding the mission of the FHA to underwriting the refinance of subprime mortgages, including loans much bigger than the agency is currently allowed to insure.

At the same time they are pushing an expanded FHA, Paulson and Bush are insisting that no taxpayer dollars will be involved in this bailout. NRO Contributing Editor Jerry Bowyer, usually a thoughtful advocate of supply-side policies and limited government, unfortunately picked up the administration spin and argued that “taxpayers aren’t footing the bill” because the FHA is “self-supporting.” But in fact, the agency itself admits that a taxpayer subsidy of more than $100 million may be required to keep it afloat in 2008 — even without any increase in its lending limit.

While it is true that some, though not all, of the FHA’s annual costs are offset through insurance premiums its borrowers pay, in the years when the cost of loan defaults exceed these premiums, it indeed may fall to taxpayers who pick up a rather large tab. And the FHA’s budget submission for 2008, as quoted in the Congressional testimony of the inspector general of the agency’s parent Department of Housing and Urban Development, states that “because of adverse loan performance, … total costs exceed receipts on a present value basis, and therefore would require appropriations . . . to continue operation.” According to the HUD inspector general, FHA now faces an estimated credit shortfall of $143 million. Sen. Patty Murray (D., Wash.), certainly not one known to bash to fiscal habits of government agencies, said in March that “the FHA’s overall financial picture is weak.” She added, “We need to make sure that we are not encouraging FHA to engage in some of the same high-risk, high-cost lending practices that are now upsetting the markets.”

But the bill that Murray and 92 other senators voted for on Friday would seem to do just that. The bill that cleared the Senate that would increase the size of mortgages the Federal Housing Administration can back, while lowering the down-payment borrowers have to put down to receive these loans. The Senate’s chief fiscal hawk, Tom Coburn of Oklahoma, was so concerned about the effects of both bills on taxpayers and the mortgage market that he put one of his famous “holds” on the Senate legislation to slow down its passage. “This bill only creates more opportunities for borrowers to receive government-backed loans, increasing the liability on American citizens, but not preventing the possibility of delinquency or default,” Coburn said in a statement.

The bill may go to a House-Senate conference as early as this week to resolve differences with the House bill, which was passed in October, before it is sent to the White House.


Sign up for free NRO e-mails today:

NRO Polls on LockerDome

Subscribe to National Review