Call it a case of implementing ‘worst practices.’ The plan unveiled by President Bush Friday to address the mortgage and credit crisis would have the Federal Housing Administration (FHA) ‘modernize’ by instituting lower down-payment requirements, allowing the FHA to insure bigger loans, and giving the FHA greater pricing flexibility. Mr. Bush also proposes a new program, FHASecure:
“The FHASecure program will help people who have good credit but who have not made all of their payments on time because of rising mortgage payments. For the first time, FHA will be able to offer many of these homeowners an option to refinance their existing mortgage so they can make their payments and keep their homes. FHA will also charge mortgage insurance premiums based on the individual risk of each loan, using traditional underwriting standards, so it can expand access and help even more families.”
Of course, there is a good reason why the FHA hasn’t ‘modernized.’ As Forbes.com noted last week, subprime loans are in default twice as often as traditional FHA loans. Why would the FHA want to implement policies that would lead directly to a doubling of its non-performing loan portfolio? The FHASecure program, as described at Friday’s press conference, would undoubtedly increase the agency’s default rate by refinancing all those existing mortgages out there in the marketplace, in effect shifting the burden to the federal taxpayer. And for those Americans hoping for sanity from the other the other side of the aisle, congressional Democrats are pressing for even looser loan requirements, further eroding any notion whatsoever of risk and responsibility.
From one perspective the growth of the subprime housing market has been a direct result of FHA’s no-nonsense approach to lending (as well as Americans’ unending desire to live beyond their means). FHA has evolved very little over the past few decades, and as housing prices in many key markets ballooned, middle-class people found themselves priced out of the market. Subprime lenders filled the widening gap, allowing working-class folks to buy a home. A recent General Accounting Office report summarizes this trend:
“From 1996 through 2005, FHA’s share of the market for home purchase mortgages in terms of numbers of loans declined 13 percentage points (from 19 to 6 percent), while the prime and subprime shares grew 3 and 13 percentage points, respectively (see figure). The agency experienced a sharp decrease among populations where it traditionally has had a strong presence. For example, FHA’s market share dropped 25 percentage points (from 32 to 7 percent) among minority borrowers and 16 percentage points (from 26 to 10 percent) among low- and moderate-income borrowers. At the same time, subprime market share among these groups rose dramatically.”
The subprime market really took off with the advent of securitization, allowing lenders and investors to divide loan pools into “tranches” with differing risk profiles. It also gave investors and lenders a false sense of security, as many felt protected from the peculiar crisis now afflicting the marketplace. But ultimately, it should be their burden to bear. It was the big-wheel investors and mortgage lenders who profited from this market during the good times, and they should now taste the bitter fruits of their broken risk models.
Indeed, if one connects the dots, it wouldn’t be such a farfetched notion to assert that the explosion of subprime loans in recent years didn’t just coincide with the housing bubble, but contributed greatly to its size and duration. The ability to secure zero-down or even 2-percent-down financing, along with teaser rates, simply kept blowing air into an already over-inflated balloon until the whole market gave way at once. And thanks to those securitized pools of loans, when the market did give way, no one seemed able to figure out his exposure to the mess, hence the freezing up of the credit market at large. Rather than returning to some sense of actuarial sanity, Mr. Bush is proposing in large part for the FHA to adopt the very policies that created the mess in the first place.
One can only hope that the president’s FHA initiative comes to same end as his immigration reforms: a press conference followed by congressional inaction.
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