Is FHA “A home wrecker”?

Edward J. Pinto, former executive vice president and chief credit officer for Fannie Mae in the 1980s and a resident fellow at the American Enterprise Institute, studied 2.4 million loans insured by FHA in fiscal years 2009 and 2010. The following are excerpts from his December 27, 2012, Los Angeles Times OpEd entitled, “The FHA: A home wrecker”:

Remember, these loans were written after the housing collapse. Today, the FHA’s risky underwriting policies are backfiring in dramatic fashion in cities across America. Even in 2012, 40% of the FHA’s loans are subprime–having a credit score below 660 or a debt-to-income ratio of 50% or more. To put this in perspective, the median FICO score for all individuals in the U.S. is 720…”

“The FHA doesn’t need to give up its mission….it needs to follow a few simple principles that will stop setting up working families to fail.

First end the practice of knowingly lending to people who cannot afford to repay their loans. To stop this harmful lending, the FHA should aim to cut its failure rate roughly in half, setting a maximum foreclosure rate (by zip code) of 10% on the loans it insures with an average foreclosure rate of 5%.”

“Taxpayers also have cause for concern……Were it a private mortgage insurer, regulators would shut it down for having a current net worth of negative $25 billion. It hasn’t kept its own house in order…..”

And here is what others have said about FHA recently:

It’s time for serious reform of the FHA before it needs a taxpayer bailout, if it isn’t already too late.” Sen. Richard Shelby

Under the law, the FHA’s net worth must not drop below 2% of the outstanding balance of the loans it guarantees. But hit by foreclosures and lower house prices, the agency’s reserve ratio has been dropping since 2006 and ended the 2012 fiscal year at negative 1.44%…..The shortfall could force it to tap the U.S. Treasury, as it is legally allowed to do, for the first time in its 78-year history.” Los Angeles Times

“In mid-November (2012), FHA’s auditor estimated that the fund, which backs $1.1 trillion in mortgages has a value of negative $13.5 billion. In other words, if it were to stop insuring loans today FHA could not cover the losses anticipated on loans it has already insured.” New York Times

“….the report’s loss estimate are somewhat surprising given that the loans it examined were made after the mortgage crisis became evident….FHA does not adequately monitor the risks in the loans it backs, the study said…..Moreover, it does not charge guarantee fees appropriately adjusted to these risks.” New York Times

M. Perry’s Thoughts Re. AEI’s Pinto’s Comments:

I think Mr. Pinto’s comments in his OpEd about FHA being an “a home wrecker” by “aggressively marketing homeownership to marginal borrowers”, “pushing them into homes they can’t afford”, and “leaving families in financial ruin” are wrong and “over the top”. Maybe I don’t understand the conservative American Enterprise Institute’s views? Is the AEI really saying that the government (FHA) must protect individual Americans from themselves and their own financial decisions?

In early 2008, as the magnitude of the crisis became clearer, I took it upon myself to develop a formal “mortgage suitability” policy and program for IndyMac Bank and its borrowers (which I completed in a matter of a few weeks and without assistance from the then non-existent Consumer Financial Protection Bureau). I did this, despite protests from some that it would make us uncompetitive, because I thought it was “good business”. I felt strongly that it would help strengthen our credit underwriting decisions, help borrowers make more-informed decisions (helping reduce investor credit losses) and decrease the risk of lawsuits. (By the way, I don’t recall a single borrower complaining that they did not understand their government-mandated mortgage forms until home prices started to decline). As a result of having a personal investment account, I recall thinking of the suitability forms I had to complete before I was able to invest. I remember asking IndyMac’s regulatory counsel who was advising me, why existing laws didn’t require lenders to determine mortgage suitability and yet they did with respect to my investment account; a uniform mortgage suitability law would have alleviated competitive concerns. I will never forget his response to me. “Mike, you are giving the investment firm your money to invest. A mortgage borrower is getting money from the bank to buy a home. That’s a big difference from a fiduciary responsibility standpoint.” That really was powerful to me. I hadn’t thought of it like that; he was right but I still built that mortgage suitability system, because I thought it was “good business”.

I tell that story, because it goes to the heart of Mr. Pinto’s inappropriate statements about FHA being “a home-wrecker”. I would be shocked to learn that the current HUD Secretary or FHA Commissioner (the mainstream press or even The Center for Responsible Lending) agreed with Mr. Pinto. But here is the thing. Many of them made these exact kinds of statements over the past several years about private-sector mortgage lenders, especially nonconforming and subprime lenders. Think about Pinto’s statement: “First end the (FHA’s) practice of knowingly lending to people who cannot afford to repay their loans”. While I admit to enjoying that statement about FHA (given how much the government has inappropriately blamed the private sector during this crisis), I don’t agree with it. It makes no rational sense, economic or otherwise. That said, I find it unbelievable and hypocritical that the Consumer Financial Protection Bureau (CFPB), who released their “Ability to Repay” rules on January 10, 2013, exempted FHA (and Fannie and Freddie), despite the fact that today FHA is the only major subprime and no (income, asset, or credit) documentation mortgage lender in the Nation (HECMs).

I do agree with Mr. Pinto that 40% of FHA’s loans in 2012 were subprime; it’s an objective fact. A recent WSJ article also noted that 33% of all student loans (another government-dominated market) were originally or have become subprime as of March 31, 2012. The idea that government-guaranteed student loans, albeit unintentionally, might have caused recent American college graduates to become subprime borrowers (because the government let them borrow too much for their education and they can’t find a decent paying job in this economy) doesn’t seem possible, does it? And yet, the CFPB will have to exempt government student loans from “The Ability to Repay” rules too, because a college student’s future employment and income are highly uncertain. I believe that’s why the government doesn’t let students discharge these loans in bankruptcy; I guess they want to hold these young adults accountable for their educational and borrowing decisions? I am not sure that’s entirely right or fair, but that’s what is happening.

The bottom line is that one government bureaucracy (the new CFPB) thinks any other government bureaucracy (FHA, Fannie, Freddie, government student loans) is a responsible party and therefore does not need to comply with prudent “Ability to Repay” rules, but those “private sector” mortgage lenders (with far less than 10% of the U.S. mortgage market today) are not responsible and can’t be trusted; I guess because many of us failed and our loans had high default rates in this crisis? Isn’t this more than a bit hypocritical? Despite its government-granted monopoly power and not-for-profit status, FHA is insolvent today too and has high default rates (FHA itself estimates the lifetime claims/default rate for its FY2007-FY2009 vintages to be 27.5%, 30.5%, and 23.73%, respectively) and losses in the bubble years and Fannie and Freddie were bailed out by U.S. taxpayers to the tune of over $140 billion and have high default rates in those years too. And all three are recapitalizing themselves through massive increases in their mortgage insurance premiums/guarantee fees; as government monopolies they can overcharge new borrowers, relative to their risk, tens of billions a year to pay for their past mistakes.

Also, I guess the government wouldn’t be originating so many subprime mortgages and student loans today, if they really believed the press and their own statements that subprime loans were bad for American consumers?

I got a little off track here, back to Mr. Pinto’s OpEd.

Over the decades, FHA has provided amazing opportunities for homeownership and wealth-building to low and moderateincome Americans, and especially first-time homebuyers. My own young parents bought a newly-built, modest tract home in Rancho Cordova, California in the early 1960’s with the help of an FHA loan. It was a big financial stretch for them at the time. FHA loans have always been a significant risk in the early years, but if FHA hadn’t taken that risk with their low-down payment, high-debt-to-income mortgages, millions of Americans like my parents (three kids, stay-at-home mom, and dad working as an auto mechanic) may never have been able to buy a home. Over time though, as FHA borrower’s incomes grow (and they generally grow faster than average because FHA borrowers tend to be younger and therefore earlier in their careers) and the home’s value in normal times appreciates (because The Federal Reserve since its founding in 1913, has consistently strived through its monetary policies to create 2% or so inflation a year), these two normal economic events act to quite substantially reduce the risk of borrower and FHA failure. I would also note that these two significant, positive future economic events are not considered in a traditional, “point-in-time” loan underwriting (Mr. Pinto certainly doesn’t consider them in his study). It has only been in this “once-in-lifetime” housing bubble and bust that FHA’s mortgage failure rate (just like the private-sector mortgage lenders) is too high. And certainly this housing bust has revealed some mistakes or flaws in the FHA program and FHA has taken several (somewhat belated in relation to the private sector) steps to correct them.

With that said, it does seem to me that some fundamental changes have occurred in America over the decades that FHA has been in existence that have likely permanently increased claims and losses to the insurance fund (e.g. reduced job stability, debt payment and savings moors, divorce rates, etc.) and these negative changes probably were masked, pre-crisis, by the long economic boom and the housing bubble and are still being masked by the housing bust and the crisis. I do agree with Mr. Pinto that FHA needs to carefully monitor its credit and prepayment performance in detail, including its independent annual actuarial reports. And use this information to make timely guideline changes and/or implement a more sophisticated, private sector-like, risk-based pricing system (to prevent private sector lenders from arbitraging FHA insurance in the future).

Posted on February 26, 2013, in Postings. Bookmark the permalink. Leave a comment.

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