A bailout for the FHA?

November 18, 2012

AS THE HOUSING market plunged into its worst crisis since the Great Depression, Congress and the White House — under both the George W. Bush and Obama administrations — turned to the Federal Housing Administration (FHA) for help.

Going beyond its historic role of insuring mortgages with low down payments for creditworthy but low-income buyers, the FHA backed the wider market through various means, among them insuring loans of up to $729,750. The FHA’s portfolio swelled to more than $1 trillion. Critics charged that the FHA lacked the capital and managerial capacity to handle this massive expansion and that the resulting losses would end up costing taxpayers billions — accusations that the agency repeatedly dismissed as exaggerated.

Right now the critics are starting to look pretty prescient. By law, the FHA is supposed to hold reserves equal to 2 percent of its portfolio. But an independent, actuarial study released Friday showed that expected losses are so high that the FHA’s reserves will be the equivalent of negative 1.44 percent, or $16.3 billion, for fiscal 2013.

The study projects $11 billion in expected proceeds from new business. And the FHA will raise premiums and sell delinquent loans, in a last-ditch attempt to avoid going to the Treasury for cash — billions, potentially — as the law permits. Finding delinquent loans to sell won’t be a problem, since one-sixth of the agency’s portfolio fits that description. All things considered, though, an FHA bailout may be inevitable.

Indeed, the FHA’s predicament is worse than the $16.3 billion figure suggests. If interest rates remain low, more high-quality loans will be refinanced out of the FHA’s portfolio, leaving the agency with the dregs. No one can predict these flows with precision, since the FHA also has a program to retain good-quality, refinanced loans. But the actuarial report suggests that protracted low interest rates could drive the FHA’s capital reserve shortfall above $30 billion.

To be sure, the FHA’s losses still reflect the impact of an especially bad crop of loans it made under very loose terms during the last couple of years before the crash. The agency has ended the policies that led to those particular mistakes. Once the crisis hit, there may have been no alternative to leaning on the FHA to help prevent an utter housing collapse. And, of course, the recent healing of housing prices is a plus for the agency.

Yet even a healing economy is a mixed blessing for the FHA. As household finances improve, more borrowers can qualify for loans without the FHA’s help, which deprives the agency of the market share it needs to bolster its portfolio.

With a bailout looming, the only question is whether Congress and the Obama administration will take this opportunity to reform the agency and the wider array of federal housing subsidies of which the FHA is a part — from the mortgage-interest deduction to Fannie Mae and Freddie Mac. What these programs have in common is that they have been used to raise the homeownership rate beyond the point of sustainability. Affordable possession of one’s own home is the American dream. Government support for excessive borrowing has turned into a national nightmare.

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