It was no real surprise last month when the Federal Housing Administration's annual accounting report found that the agency was in the red to the tune of $13.4 billion, among other problems. FHA has been bleeding cash over the past few years from delinquent mortgages it guaranteed during and after the recessionary rush to housing. And, unfortunately, FHA has not taken the proper measures over the past four years to stem the tide of those losses. Congress needs to start phasing out the insolvent agency now, or it is possible taxpayers could be on the hook for yet another massive bailout in 2013.
The Federal Housing Administration was originally instituted to boost homeownership among low-income families. The idea was to help families who might not be considered good credit risks by the private sector to get more affordable mortgages without having to offer a normal down payment that the private sector requires. FHA guarantees a bank that if a homeowner misses his or her mortgage payments it will cover the bank's losses. This allows the bank to extend low interest rates -- even to homeowners who offer just a 3.5 percent down payment, have weak credit scores, and have high debt-to-income levels.
During the build-up of the housing bubble FHA began to expand its role beyond serving the poor, and guaranteed billions in toxic subprime mortgages. And since the bursting of the housing bubble and the financial meltdown, the 78-year-old agency has doubled down on its expanded role, guaranteeing mortgages worth up to $729,750. FHA now controls 30 percent of new housing finance. And, along with the government-sponsored enterprises Fannie Mae and Freddie Mac, it dominates more than 90 percent of the mortgage finance market today.
But the 2012 actuarial report found that the housing agency's value has fallen $23 billion in the past 12 months primarily because of losses on mortgages it guaranteed from 2007 to 2010. And it is looking at a possible negative $93.7 billion valuation in the next five to seven years with those losses piling up.
About 25 percent of mortgages FHA guaranteed in 2007 and 2008 are seriously delinquent (90 days of missed mortgage payments or more), and more than 12 percent of 2009 mortgages are just a step away from foreclosure. (In normal times those numbers would be 5 percent or less.) FHA's own actuarial review estimates nearly $40 billion will flow out the door to cover losses related to these delinquencies.
What's more, notes Wharton School real estate professor Joseph Gyourko, FHA is currently leveraged 41-to-1 -- which is higher than either Lehman Brothers (31-to-1) or Bear Stearns (38-to-1) when they collapsed. The November report also shows that the federal agency is $34.5 billion short of the capital Congress requires it to hold relative to risk.
None of this should come as a shock. That's because when the rest of the industry tightened lending standards following the housing bubble, FHA kept them relatively loose in order to prop up the struggling housing market. For instance, some borrowers spending up to 50 percent of their monthly salary to service their debt are granted loans backstopped by the FHA. Apart from propping up the housing market, FHA was justifying its shoddy lending practices by the dubious theory that the way out of its piling losses from the collapse of the housing bubble was by expanding its business and revenue stream. According to Ed Pinto, FHA's insurance portfolio has quadrupled in the past 5 years to $1.1 trillion. Talk about too big to fail!
The only reason FHA is not officially defunct is because Congress has authorized it to operate under special accounting rules that allow it to project positive value and remain operational even in the face of these difficulties. Mr. Pinto estimates that under generally accepted accounting principles (GAAP), FHA's net worth would be even lower than $25 billion. FHA's suspect accounting practices also allow it to operate under its Congressionally mandated capital buffer, and Barclay's estimates that even if FHA avoids a bailout, losses will remain so high that FHA will remain below its capital requirement until at least 2017.
Yet, FHA's administrators deny there is anything wrong with the agency. Acting FHA Commissioner Carol Galante and Secretary of Housing Shaun Donovan insist that FHA is not a private business and should not be run like one. In plain English this means that the FHA should not be held to the same rules that private firms are because the government's backing means it is not exposed to the same risk. This is exactly the mentality that caused Lehman to chalk up so much bad risk. But just as with Lehman, taxpayers will end up holding the bag.
To minimize taxpayer losses Congress could at least try to force the FHA to perform more responsibly. This means changing FHA's accounting rules to make it operate like a private mortgage insurer. It means forcing FHA to dramatically raise fees charged to mortgage investors for guaranteeing they get paid above current planned rate hikes. And it means the size of mortgages FHA can insure should be lowered from the absurdly high $729,750 to 80 percent of median housing prices measured at the local level so that only the truly poor qualify for its guarantees. This will go some way in ensuring that taxpayers are not being asked to take undue risk.
It is not at all obvious that FHA's core mission is even worth it, however. Conventional wisdom suggests that homeownership is a public good and Washington should subsidize it. This only serves to keep the price of housing artificially high -- remember the bubble? -- and makes it unaffordable for the poor in the first place. If Congress truly wants affordable housing, it can start by phasing the FHA out of its misery.
Like any other overleveraged financial institution taking on too many losses, FHA should be taken through a bankruptcy process where the banks that were depending on the guarantees are forced to take a hair cut now -- instead of taxpayers taking losses later. FHA's business can be liquidated and its portfolio of insurance contracts sold off (at a discount of course)without hurting Americans currently with FHA loans.
Dissolving the FHA would protect taxpayers from billions in bailouts and give the federal government pause before it launches future endeavors that might require more billions in bailouts down the road.
Anthony Randazzo is the Director of Economic Research at the Reason Foundation. He can be reached at firstname.lastname@example.org. This first appeared at RealClearMarkets.com.