Conservatives and liberals met on Capitol Hill to talk about ideas for "reforming" the troubled Federal Housing Administration (FHA), an agency within the Department of Housing and Urban Development (HUD) that guarantees mortgages that are supposed to enable low- and moderate-income people to own homes with down payments of about 4 percent.
The event was sponsored jointly by the American Enterprise Institute (AEI) and the Center for American Progress (CAP). The featured paper was presented by Joseph Gyourko, a professor of real estate, finance and business and public policy at Wharton, and was followed by comments from AEI's Edward Pinto and Wells Fargo's James Carr.
The discussion took place against the background of a Wall Street Journal report that an undisclosed stress test estimates potential losses at the FHA at $115 billion.
Gyourko explained that the FHA is essentially insolvent and that this condition is the inevitable result of a business plan that enables leverage in the vicinity of 40:1, and with a down payment of 3.5 percent, the borrowers are leveraged 30:1. Therefore, this arrangement, while it may work for a while, is so vulnerable to any adverse event(s) that even if it were well-managed, it would not be able to make it through an entire business cycle without failing.
Further, he warned that if the FHA is not recapitalized before another event occurs, it will be even more vulnerable to a breakdown of systemic proportions.
This inevitable vulnerability is compounded, according to Gyourko, by the fact that the model the FHA uses to predict the risk of default due to unemployment underestimates it by a factor of 100. He noted that the FHA is a financial train wreck waiting to happen, and presented four potential options:
1. Do what we're doing now, which is to adopt modest reforms, but not enough to change the long-run outcome and which entails an unacceptably high default rate of 12 to 13 percent.
2. Reform the FHA in a more fundamental way by setting strict limits on underwriting to the extent that it would not be allowed to guarantee a mortgage with a probability of default of 10 percent or higher. Gyourko dismissed this idea because he doesn't believe the reforms would hold.
3. Eliminate the FHA, a credible option for those who believe that failure should be punished, but he argues that Congress created the FHA to fulfill a mission of serving households with low down payments and first-time homebuyers.
4. Require a 10 percent down payment and subsidize borrowers to accumulate the required down payment by having the government contribute $2,000 against $1,000 that the borrower would save each year for five years. The total cost of a program to serve 500,000 households would be $1 billion, and Gyourko finds this acceptable compared with the $115 billion the FHA is likely to lose anyway.
In their comments, Pinto presented, as he has been doing at AEI and other forums, a plan to cut the probability of default on FHA loans roughly in half, to the neighborhood of 7 percent, by adopting best practices as implemented by the Veterans Administration (VA) for its loan program.
Carr responded by defending the FHA as "by many measures, an exceptional success," and he insisted that "the sky is not falling." On a roll, he further asserted that the problems at the FHA are not due to its government status, and he contended that improvements in the FHA's management could enhance its financial well-being. The punch line is that he thinks a federally subsidized savings program along the lines suggested by Gyourko is "an exceptional idea."
I have observed, from many years of watching the HUD and FHA cavort through the U.S. financial landscape that the real purpose of the FHA is to enable the mortgage industry to offer attractive products that generate fees to a broader audience than would be possible without government support, without putting up any capital of its own. The low- and moderate-income homebuyers are pawns in this scheme, and so are the taxpayers.
Gyourko does not subscribe to the belief that federal programs financed with guarantees rather than appropriations are free, and that's reassuring. However, one is left to wonder whether he has considered the fact that in order to help the lucky 500,000 "targeted households," it is necessary to impose costs, however hidden, on those who are not targeted and have housing needs of their own to finance.
Even the Gyourko acknowledged that the politicians that conceive of programs like the FHA can't resist expanding them and diluting whatever underwriting safeguards they put in place at the outset in order to gain support. An educated cynic must suspect that the toxic financial products that will cause future episodes of the ongoing financial crisis are being conceived today in meetings like this one.
Therefore, the preferred choice is #3, get rid of the FHA. As for the reaction of a Congress largely enthralled by the Housing Industrial Complex, with many members personally affiliated with banking, mortgage banking, home building, real estate and insurance segments or acting as lawyers for these lightly-funded enterprises, it's time to plead mortgage finance fatigue.
Citizens have enough trouble financing their own homes and businesses without having to help their neighbors realize the American Dream through the failed FHA.
However, if one finds it impossible to go cold turkey and is still compelled to follow the Washington maxim that "nothing succeeds like failure," an alternative would be to approach some of the oligarchs who have made fortunes in the financial arena and ask them if they think programs like the FHA or a generous subsidized down payment program like the one Gyourko proposes are such wonderful ideas, to put up the money to fund it.
There are social Democrats like Warren Buffett who have more discretionary funds than the federal government and could easily finance a billion-dollar program or take a share of a privatized FHA if they chose to.
This is all the more appropriate given that Buffett is a large stockholder in the company Carr represents. As Milton Friedman said, "Everyone has a right to do good with his own money."
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