As we enter the summer and the housing market continues to recover from the Great Recession, what seems like an annual ritual has begun again. Rumors have started, and positions are being put forth that the Federal Housing Administration (FHA) should reduce its premiums yet again. This is the wrong thing to do on many levels.
Let me be clear that the FHA has and does play a very important role in our country’s housing market. As the leader of a private mortgage insurer, I am not anti-FHA. In fact, over the years the private mortgage insurers have approached the FHA to pursue a more collaborative role in collectively serving our country’s housing needs, though without success. Rather, the debate is around the proper role for the FHA. There is a great deal of discussion swirling around about the future of the GSEs, Fannie Mae and Freddie Mac. But other than some dated proposed legislation it seems no one is talking about the proper role for the FHA. This blog is not intended to get into the entirety of the policy debate around the FHA. Rather, this blog specifically addresses the need to identify the FHA’s role before considering any possible premium cut.
The FHA often has said it has twin purposes, 1) to serve as countercyclical capital particularly during times of regional or national economic stress and 2) to facilitate homeownership for low and moderate income families. Let me address each.
The housing market is well on its way to recovery. There is no need for government action in the form of providing countercyclical capital that is necessary at this point in time. There are many statistics that support that this recovery is well in place. In fact, over the past couple of years the various leaders of Housing and Urban Development (HUD) and the FHA have stated that with a recovery in mind they would hope that the FHA’s percent of the insurable residential mortgage market should return to its historical levels. The chart below shows those levels. It clearly does not look like those words are being met with action. The FHA’s share of the insurable market has not returned to its historical levels and, in fact, the FHA market share has increased since its January 2015 premium rate cut.
In regard to facilitating homeownership, the FHA’s mission is to assist underserved households to attain affordable homeownership. Presently, the FHA is straying from that mission. According to the 2014 Home Mortgage Disclosure Act data, 42% of FHA borrowers earn greater than the area median income (AMI). Additionally, the FHA claims that approximately 20% of their purchase volume comes from repeat buyers. These borrowers likely have private sector alternatives that would not further expose US taxpayers. The GSEs and the state HFAs ensure they are targeting the appropriate borrowers by enforcing AMI limits and/or first-time home buyer restrictions on their affordable programs. The FHA should do the same to ensure it stays squarely focused on the households with the greatest need.
It has been reported that the recent volume insured by the FHA has credit scores greater than 700 more than 30% of the time. The question has to be asked why the United States Government and we as taxpayers are providing insurance to borrowers with strong credit profiles. This is hardly the mission-driven segment of the market the government needs to support. The private sector is perfectly suited and equipped to serve that market, thus reducing taxpayer risk.
In many respects the GSEs, representing the conventional market and the FHA representing the government are competitors in the high LTV space. Within the last couple of years, the GSEs re-entered the 97% LTV market with hopes of providing greater access to credit supported by private capital, such as private mortgage insurance. One effect of this would have been moving business from the FHA to the GSEs. Shortly thereafter the FHA announced a significant premium cut (37%) which for all intents and purposes muted the impact of the GSE programs. The significance of this is that the FHA insurance covers 100% of the loan balance for the life of the loan. On the other hand, on loans with LTVs greater than 80% the GSEs are required to have credit enhancement, most often in the form of private mortgage insurance. The GSEs’ exposure is typically the bottom 70% of the loan, making losses to them more remote, and, in contrast to FHA’s 100% exposure to loss. So, in effect, the FHA move, while intended to provide additional access to credit, worked against the GSE/private capital program, and caused the exposure for loss to move from the private sector (PMI) to the taxpayer.
In addition, the GSEs have been directed by their regulator, the Federal Housing Finance Agency (FHFA), to reduce their mortgage credit risk even further. Over the last couple of years the GSEs have been doing what is known as risk sharing transactions the goal of which is to further de-risk the GSEs and in turn reduce taxpayer exposure. Any reduction in FHA premiums will in effect mitigate that goal by moving business from the GSEs/private sector to the government/taxpayer. These are contradictory actions by our government. In fact, it is crazy housing policy but that is a subject for another blog.
Should the FHA feel the need to reduce premiums further (which I obviously think is not warranted) it should be 1) limited to FICOs below 680 where the FHA can truly fulfill its mission and/or 2) establish a median income test based on MSA. Further, the program should also be limited to first-time homebuyers. There is no reason why someone making an income in excess of AMI with a FICO score greater than 700 should be turning to the government for assistance. And, that is certainly true when one looks past the FHA and realizes the FHA equals taxpayers.
The FHA actuarial report is due for its annual update in November. Given the general quality of loans being originated today, it is reasonable to expect that the Forward Mortgage component of their capital will improve, perhaps even coming in above the 2% minimum capital requirement. A 2% minimum capital level (a 50:1 leverage ratio) is inadequate, particularly when you consider that the private mortgage insurers hold minimum capital equal to approximately 7% (a 14:1 leverage ratio). In addition, as I have stated, the FHA insures loans for the life of the loan. Just because things may look better today does not mean that they will look good a few years down the road or when the next recession will occur. They need enough capital to cover many economic scenarios over various cycles and 2% at a point in time is woefully inadequate as the Great Recession proved. If the FHA reduces premiums again, and uses the same 2015 premium reduction talking points, they will likely say they are providing access to homeownership to thousands of more borrowers, and that this premium reduction will not impact capital because of the additional premiums generated by new homeowners. That is a “make it up in volume” strategy, using taxpayer dollars. That is not sound housing policy.
In summary, there is no justifiable reason for the FHA to consider reducing its premiums without first addressing its role. The market is well served by the private sector during these better economic times. And further, doing so actually increases taxpayer exposure, a situation no one should favor.
Tags: FHA, GSEs, Homeowner, housing, Housing Policy, Mortgage Education, Mortgage Industry
President & CEO MGIC – One of the Nation’s Largest Private Mortgage Insurers