Federal Housing Administration: The Next Bailout Request?

We will probably never know how much the housing bubble burst cost the American people and the U.S. economy. The impact was too deep and too wide and spread too far throughout the entire economy for anyone to figure out how much money was lost, how much was paid out in bailouts, and how much economic activity disappeared.

Suffice it to say, it was a lot. And the U.S. economy is still feeling the effects like a bad hangover. Unemployment is stuck somewhere north of 9 percent, we may be headed into a double-dip recession, and the housing market still hasn’t recovered. Plus, far too many homeowners are still finding that they are underwater, living in houses that are worth less than what is owed on them.

You’d think this would be a cautionary tale, one that demonstrates what happens when the government gets too deeply involved in the private marketplace. Unfortunately, some policymakers have not learned the lessons of the bubble burst. They are still trying to micro-manage federal assistance to home buyers, leaving everyone exposed to risks that are too high.

Back when everything was falling apart, Congress took steps to temporarily raise the upper limit for Federal Housing Administration-insured loans (as well as the limit on government-sponsored enterprise conforming loans) by just over $100,000, taking it from $629,000 to $729,750 in certain parts of the country where homes are particularly expensive.

Some members of Congress want the limit to stay where it is, as CQ reported Friday:

In a letter Thursday to House Appropriations leaders, Rep. Gary L. Ackerman, D-N.Y., and three dozen other lawmakers urged a one-year extension of the current "conforming loan" limits that are set to expire at the end of the month.

This is a bad idea. The limits should be allowed to revert to where they were before they was raised, as is scheduled to happen on October 1, 2011 -- a position the U.S. Department of Housing and Urban Development seems to support, or did as recently as the middle of August.

How did the FHA increase work? Two professors from George Washington University -- Robert Van Order and Anthony Yezer -- found that:

The 2008 expansion of FHA’s loan limits gave the program, which previously had focused on low-to-moderate income and first-time homebuyers, the ability to insure nearly 97 percent of the available low down payment market for home purchase.

...

As a result, FHA’s share of the home purchase market increased from 6 percent in 2007 to more than 56 percent in 2009. Additionally, we found that FHA-insured loans that were more than $350,000 had default rates that were approximately 20 percent worse than those on smaller loans. Thus, it is not clear that enlarging FHA market share by maintaining high loan limits is a good way to recapitalize the insurance fund; nor is it clear that FHA is flexible enough to operate for long periods of time with a large market share.

To put it another way, the change in the limits has made -- as Tom Kelly put it in a piece for Inman News -- the FHA the “go-to-guy” for home loans:

All FHA loans are insured by the federal government against default. Since the mortgage meltdown and the resulting stringent lending guidelines, more borrowers have taken the less onerous road offered by FHA requirements.

This has led to the unintended consequence of people who were never supposed to be getting loans backed by the FHA seeking them out. As Kelly puts it:

FHA was founded to make loans to a select number of people based on need and income. It has grown from funding 3 percent of all mortgages in 2006 to more than 40 percent today.

And the U.S. taxpayers are potentially on the hook for all of it.

FHA is already significantly undercapitalized as a result of the housing crisis. If FHA’s resources are even further constrained by extending the increased loan limits, we may soon be adding FHA to the list of entities that the government has bailed out. We are all too familiar with Fannie and Freddie’s outsized footprint on the mortgage market and the costs to taxpayers, but there is still a chance to rein in the FHA’s expanded role by allowing the FHA loan limits to expire on October 1 as scheduled.

There are still miles to go before a solution to the housing crisis is achieved, but in order to get there, sound policy is required. This means reducing the exposure of the U.S. taxpayers to risky mortgages.  Reducing the role of the FHA in the marketplace, thereby allowing the FHA to refocus on its original mission -- to help first-time home buyers purchase homes -- is a no-brainer.