The Federal Housing Administration's (FHA's) Sept. 18 annual report indicated that its reserves would fall below the legally mandated level for the first time in its 75-year history.
During the current recession, the New Deal-era FHA's share of government underwritten mortgage business in the U.S. has surged to 23%, despite increasing concern about asset quality and potential losses. Following its report, there are fears that the FHA's financial woes could necessitate a significant injection of government funding.
Washington plays a central role in the housing market through government sponsored enterprises (GSEs) Fannie Mae and Freddie Mac, which support the market for fixed-rate mortgages by securitizing and selling them on to investors, and the Federal Housing Administration (FHA), which insures certain mortgage loans. However, FHA may soon become the latest fiscal drain on the U.S. Treasury.
FHA significance. Although the asset bases and potential liabilities at Fannie and Freddie are much larger, FHA is also very significant, in both political and fiscal terms. It often underwrites mortgages through approved intermediaries to home buyers with little capital to put down--as low as 3.5% of the asking price. Such small equity stakes rapidly push borrowers into 'negative equity' if housing prices decline--as they have done spectacularly since late 2006. Negative equity conditions significantly increase the chances that a borrower will default on a mortgage, creating a loss for the FHA.
FHA distress. Congress mandated FHA capital reserve requirements, which the agency must strictly observe. Falling below its minimum capital threshold would require additional federal funds--a scenario that appears increasingly likely. In June 2008, 5.4% of FHA backed mortgages were 90 days late or more, a figure that surged to 7.8% a year later.
The agency's woes have several key causes:
--Sudden market shifts. Historically, FHA has imposed sound documentation and credit standards on the mortgage companies it backed, and it has not diluted this approach. Rather, as major private lenders abruptly tightened their rules in 2006-08, borrowers with relatively weak credit records were pushed into the arms of FHA-backed firms. Consequently, FHA's market share surged from 3% in 2006 to 23% this June; according to its most recent accounting, the agency now underwrites nearly 80% of U.S. mortgages taken out by first-time buyers. In the context of the worst housing market collapse since the 1930s and a severe recession, FHA's normally prudent lending standards proved inadequate--setting it up for major losses.
--Public policy. Homeownership has traditionally been viewed as a social virtue that should be encouraged by public policy. These efforts have largely succeeded, as homeownership grew from less than 40% in the 1930s to over 66% last year. However, minority homeownership has long lagged that of the white population--due, in part, to discriminatory policies pursued by FHA and other federal agencies through the 1950s. Paradoxically it was a concerted government effort to close the homeownership gap among minority groups--particularly under former Presidents Bill Clinton and George W Bush--that helped encourage the rapid growth of the sub-prime market. This contributed to price rises in the broader market, affecting mortgages taken out by supposedly creditworthy borrowers with little initial capital, underwritten by FHA.
--Taxpayer support? If FHA does need taxpayer support, it will be a politically damaging precedent (the agency's Web site boasts that it is self-funded). At present FHA insures nearly 5 million single-family mortgages and 13,000 multifamily projects. If the agency is forced to reduce its participation in the marketplace, mortgages could become significantly more expensive, undercutting the tentative housing market recovery (according to the latest S&P/Case-Shiller housing market index data).
Outlook. FHA has been a vital source of support for the U.S. property market, particularly for first-time buyers, so the government will not hesitate to recapitalize the agency if it suffers further reserve erosion. However, over the long term the substantial federal role in the housing market may face political scrutiny and reform.
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