The Federal Housing Authority is about to draw on federal funds for the first time since it was created during the Great Depression — it says it’ll need about $1.7 billion to fix the hole created in FY 2013, though it insists it won’t need any funds in 2014. Are we looking at another Fannie/Freddie-like bailout? Not really, but there are reasons to be concerned.
The FHA is a government agency and a different kind of entity from Fannie Mae and Freddie Mac, “government-sponsored enterprises,” though they both exist, essentially, to subsidize the U.S. housing market. Fannie and Freddie, though, actually deal with mortgages themselves — they buy them from private lenders, and then hold the securities themselves or sell them on to outside investors (private investors, the Federal Reserve, the Chinese government, etc.). The FHA does something else: It insures mortgages against default, so if a borrower who gets FHA insurance on his loan and is foreclosed on by a private lender, the FHA compensates the lender for the balance of the mortgage. The FHA pays for this service by charging the borrowers a fee when they take the loan out and then each year. Paying for the insurance, which makes the loan a lot safer for the bank, means the borrower can get lower rates, put down a smaller downpayment, or get a mortgage the private lender would never otherwise approve.
Thanks to those fees, the FHA is self-funding, but it’s no free lunch — the reason it’s a good deal for consumers (or for many of them) is that they can purchase the insurance for less than it should actually cost, because of the value provided by the FHA’s being backed by the federal government. There are private insurers, too, so the idea of transferring the bank’s risk from being based on an individual’s behavior to a larger institution’s guarantee isn’t a unique service the federal government offers. But the FHA insures mortgages that wouldn’t be able to get private insurance, or where private insurance would be much too expensive. How does it afford to do that? The federal government’s guarantee is basically perfect and riskless, and the FHA doesn’t technically pay anything for the privilege, lenders and borrowers come out ahead (though FHA prices have gone up of late), and that’s a boost to the housing market. (With Fannie and Freddie on a very tight leash and private borrowers raising requirements, the FHA has gotten a lot more popular, going from 4 percent of mortgages in 2007 to 15 percent of mortgages now.)
This week’s development reminds us that the feds’ guarantee does come with costs – the FHA is more than a billion dollars in the red this year, so it’s going to get a cash infusion from the federal government (which actually doesn’t have to be authorized — the backstop is automatic, apparently). The FHA is confident it’s going to do better in future years, and claims this is more of a liquidity problem than a solvency problem, as the saying goes, and they’re probably right: The losses that put them where they are now aren’t from subprime home loans, but from reverse mortgages — a business the FHA stopped doing in 2008. However, in future years, with the sheer size of the FHA portfolio, it certainly would suffer substantial losses if there is indeed another subprime meltdown.
The FHA’s also been involved in another important controversy of late: It investigates borrowers for their credit history, limits mortgages it’ll insure to a certain amount, and doesn’t insure mortgages with less than a 3.5 percent downpayment. That’s not incredibly stringent, but a federal government that’s been on-and-off trying to help a housing recovery has decided that’s enough for loans with FHA insurance to be exempt from some other regulations, including something called a risk-retention requirement, intended to curb risky lending. Obviously FHA loans are safer than your average mortgage, but a lot of people are concerned by the feds’ shift in this direction — Fannie and Freddie loans will also be exempt from some of these rules. A housing recovery will be an immensely helpful thing for our economy, but, as it seems almost everyone would agree, the U.S. housing market needs to be rebuilt on a firmer foundation than it sat over for the last couple decades. Expanding the FHA and using its judgments to loosen other credit requirements isn’t a great way to do that.