Why housing didn’t bottom out

“Yesterday’s subprime is today’s FHA. It’s a definite train wreck and the flag will go up in the next couple of months: Bail us out. Give us more money.”
--Robert Toll, CEO, Toll Brothers Inc.

Back in March, I pointed to an article by Henry Blodget as a pretty good articulation of why housing prices probably had much farther to fall before stabilizing, yet as the year dragged on, housing prices did stabilize somewhat, much to my amazement.

An article on B1 of today’s New York Times (“With F.H.A. Help, Easy Loans in Expensive Areas”) is lighting up the blogosphere and goes a long way toward explaining why.

It seems much of the loan alchemy practiced by the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) in the late stages of the housing bubble has now been picked up by the Federal Housing Administration (FHA).

The Times story details how three down-and-out guys with paltry collective assets were able to finance the purchase of a million-dollar apartment building in Boston, putting down a total of 3.5 per cent and financing the rest through the FHA. The article details how, thanks to the Economic Stimulus Act of 2008, the FHA’s role in the mortgage industry has drastically increased, offsetting the bailed-out failures of Fannie and Freddie. The legislation doubled the loan limits of FHA, in effect, opening the agency up for doing business with middle- and upper-class folks, rather than the working-class poor for whom the agency was created. The article also demonstrates how our Boston trio is not an isolated case.

This change in FHA policy was accompanied by an increase in loan activity, such that, today, the agency “has an abysmally low 0.53% insurance reserve ratio,” as Edward Harrison over at Naked Capitalism puts it. In other words, the agency has greatly ramped up its lending, even as its financial resources are put under greater strain. FHA activity has probably had an appreciable effect on stabilizing housing values. According to Bloomberg, Housing and Urban Development Secretary Shaun Donovan was quoted on November 12 as saying that FHA “guarantees one of every five single family loans.” Quantifying the cost of this activity is less clear, unfortunately, because of the slapdash, panicked atmosphere that prevailed at the time the Economic Stimulus Act of 2008 was passed. It is not entirely clear how FHA accesses taxpayer money: does it need Congressional approval, or might it simply make a request directly to the US Treasury? If the latter scenario is the case, it doesn’t bode well for transparency or accountability.

And yet even as the HUD secretary characterized FHA as being in “real risk” of further cash infusions to keep the agency going, Barney Frank (D-MA), chairman of the House Financial Services Committee is pressing to increase the agency’s loan cap still further by an additional $100,000.

The Frank approach is not evil, and it’s not stupid. I can see perfectly clearly why Congressman Frank and his colleagues are doing this. It’s basically an attempt to outrun the same monsters that were menacing us last year at this time. The logic goes something like this: to save ourselves, we have to save the banks; to save the banks, we have to preserve housing values, because bank exposure is astronomical and any significant decline from here in housing values would, in effect, destroy the entire U.S. banking system. Their thinking is that, if we can just put the mortgage industry into some kind of protective coma, it buys us time to fix the economy, put people back to work, and see some kind of broad economic growth, i.e., we’ll be in a stronger position then to help banks unwind their bad bets by slowly letting the air out of the housing market.

However, there are significant flaws with this approach. First, Frank and his minions discount the sheer amount of taxpayer money required (a) to prop up housing values and (b) to spur a requisite level of employment and growth. It simply is not going to be possible to achieve these goals through the public purse without doing permanent damage to the country’s long-term finances with attendant hyperinflation and dollar devaluation. Second, the “value” and “growth” achieved through direct federal intervention is and would be transitory and unsustainable. As soon as stimulus is removed from the housing market or the larger economy, levels of demand would plummet. Remember, folks, the government is basically aiming to sustain a level of demand (in housing and more generally) that is well beyond our economic means.

The Frank approach, therefore, is destined to fail. It is, at best, a short-term solution, a plan designed to kick the can further down the street with the assumption being that the street never ends.