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Follies of the FHA: Another subprime idea

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Follies of the FHA: Another subprime idea

Berlau Article in National Review Online

"How could they have been so stupid?” That's the million-dollar question being asked as mortgage defaults have increased on loans that carried much more risk then lenders, borrowers, and investors anticipated.

But this question may be overtaken by one with a multibillion -dollar price tag years from now. That may be, “How could our elected representatives have been so stupid?” Despite the valiant efforts of fiscal hawks such as Sen. Tom Coburn (R., Okla.), and several House members in the conservative Republican Study Committee, both bodies of Congress have passed bills to put taxpayers on the hook for more risky loans from the Federal Housing Administration (FHA). And the Bush administration is supporting these bills, despite the fact that this government agency already has a subprime record of subsidizing loans.

Bush has, in fact, made the FHA — an agency created during Franklin D. Roosevelt's “New Deal” in 1934 to help low and middle-income borrowers obtain housing — a centerpiece of the mortgage “rescue” plan announced this month by Treasury Secretary Henry Paulson. The plan — which would freeze introductory rates of adjustable-rate loans for five years for some borrowers, and which an NR editorial castigated for “rewarding irresponsible lending and borrowing” and potentially doing “enormous damage to the reputation of securities backed by American debt” — hinges on subprime borrowers refinancing into an FHA fixed-rate loan as the rate freeze “thaws.” That's why, in his speech announcing the plan, Paulson also called on Congress to pass legislation to “help refinance another estimated 200,000 families into FHA-insured loans.”

The FHA insures a mortgage from default up to a limit of about $365,000. This greatly reduces a bank's risk from making these loans, but can also create a substantial “moral hazard” because of the taxpayer backing.

Because of proliferating mortgage options and soaring housing prices, FHA-backed loans declined as a share of the mortgage market over the past decade. But now with current mortgage woes, both the Bush administration and Democratic leaders support expanding the mission of the FHA to underwriting the refinance of subprime mortgages, including loans much bigger than the agency is currently allowed to insure.

At the same time they are pushing an expanded FHA, Paulson and Bush are insisting that no taxpayer dollars will be involved in this bailout. NRO Contributing Editor Jerry Bowyer, usually a thoughtful advocate of supply-side policies and limited government, unfortunately picked up the administration spin and argued that “taxpayers aren't footing the bill” because the FHA is “self-supporting.” But in fact, the agency itself admits that a taxpayer subsidy of more than $100 million may be required to keep it afloat in 2008 — even without any increase in its lending limit.

While it is true that some, though not all , of the FHA's annual costs are offset through insurance premiums its borrowers pay, in the years when the cost of loan defaults exceed these premiums, it indeed may fall to taxpayers who pick up a rather large tab. And the FHA's budget submission for 2008, as quoted in the Congressional testimony of the inspector general of the agency's parent Department of Housing and Urban Development, states that “because of adverse loan performance, … total costs exceed receipts on a present value basis, and therefore would require appropriations . . . to continue operation.” According to the HUD inspector general, FHA now faces an estimated credit shortfall of $143 million. Sen. Patty Murray (D., Wash.), certainly not one known to bash to fiscal habits of government agencies, said in March that “the FHA's overall financial picture is weak.” She added, “We need to make sure that we are not encouraging FHA to engage in some of the same high-risk, high-cost lending practices that are now upsetting the markets.”

But the bill that Murray and 92 other senators voted for on Friday would seem to do just that. The bill that cleared the Senate that would increase the size of mortgages the Federal Housing Administration can back, while lowering the down-payment borrowers have to put down to receive these loans. The Senate's chief fiscal hawk, Tom Coburn of Oklahoma, was so concerned about the effects of both bills on taxpayers and the mortgage market that he put one of his famous “ holds ” on the Senate legislation to slow down its passage. “This bill only creates more opportunities for borrowers to receive government-backed loans, increasing the liability on American citizens, but not preventing the possibility of delinquency or default,” Coburn said in a statement .

The bill may go to a House-Senate conference as early as this week to resolve differences with the House bill, which was passed in October, before it is sent to the White House.

The House bill greatly differs from that of the Senate; it is much worse! Written by House Financial Services Committee Chairman Barney Frank (D., Mass.), the bill increases the loan limit for FHA insurance to almost $800,000 in some areas, and would allow the agency to insure mortgages with zero down-payment. It also creates an “Affordable Housing Fund” within the agency that could siphon off any money left over from premiums for politically-oriented “housing advocates” such as the Association of Community Organizations for Reform Now (ACORN).

An analysis by the conservative Republican Study Committee in the House noted that “since money is fungible,” the housing fund may “allow liberal activist groups, like ACORN and La Raza, that perform some housing-related activities to use taxpayer dollars to indirectly subsidize their big-government, anti-conservative advocacy nationwide.” Even if the fund is used entirely for housing-related activities, it would still siphon away FHA savings, hurting the agency's long-term solvency.

At this point, legislative blocking of the conference bill that emerges — when it comes up for a new vote in each chamber — may be the only shot at the bill's defeat. Although Bush has expressed concerns about House bill provisions such as the “affordable housing fund” — and has a much-improved record on using the veto pen in general — some press reports indicate that he is prepared to sign whatever FHA bill comes out of conference.

For whatever reason, Bush had become an unlikely champion of this New Deal agency, even before the credit crunch began. And using rhetoric often indistinguishable from Democrats such as Frank and Sen. Chuck Schumer, (D., N.Y.), administration officials have sung the agency's praises. Take Brian Mongomery, HUD's assistant secretary in charge of FHA. The Associated Press recently quoted him as saying that “the entire mortgage market needs the stability that FHA brings.”

But far from bringing stability to the mortgage market, over the past decade — under both the Clinton and Bush administrations — the FHA's underwriting methods have rivaled the carelessness of many subprime lending practices, and have contributed to current housing woes. The delinquency rate on FHA-baked mortgages has been close to that of the subprime category and has sometimes even exceeded it. In the last quarter of 2006, for instance, the delinquency rate for subprimes had increased to 13.33% in the industry's National Delinquency Survey . But in the FHA category, the rate had risen to 13.46 percent — “a new record.” This is especially disconcerting considering that FHA borrowers are said to have better credit records than many who get subprime loans.

And in some regions, FHA-insured loans have accounted for a disproportionate share of mortgage woes. An investigation by the Denver Post lays much of the blame for foreclosures in certain areas on FHA products. The newspaper found that while the FHA backed less than one-fifth of home loans in two Denver-area counties, the loans that were FHA-insured actually accounted for about a third of the counties' foreclosures.

And if you were to Google the terms “FHA” and “mortgage fraud,” a number of interesting entries would come up in your search, describing indictments and prosecutions of speculators, lenders, and other mortgage market players for schemes utilizing FHA-backed loans. Of course, mortgage fraud can and has occurred with many types of loan. But a 2001 Senate investigation led by moderate Sen. Susan Collins, R-Maine, found that FHA-backed loans were particularly advantageous to fraudsters targeting low-income families, because “if the buyer defaults, the government will reimburse the lender for almost the entire amount of the loan.” At a hearing on mortgage market abuses, Collins said , “What I find most appalling is that the federal government has essentially subsidized much of this fraud.”

The FHA has attempted some reforms, but the “moral hazard” of taxpayer-backed loans remain that same, and will likely increase if loan amounts are bigger and down payments are smaller. Yet, politicians, advocates, and many in the private sector are jumping all over themselves to restore the dominance of this New Deal edifice. Before they go rushing to make the government, once again, a big mortgage player, they should learn the real lessons of the Depression era in which the FHA was created. In her new book, The Forgotten Man , Amity Shlaes shows definitively how the interventionist policies of both Herbert Hoover and Franklin D. Roosevelt turned a market correction after the 1929 stock-market crash into the ten-year Great Depression. The most important thing Congress can do to heal housing woes is to not ram through ill-thought cures — whether subsidies or regulations — that may end up making things worse.