February 20, 2012

IS THE FEDERAL Housing Administration the solution to the current housing meltdown or the cause of the next one? Formerly an obscure agency with a limited mission — insuring mortgages with low down payments for creditworthy but low-income buyers — the FHA has filled the gap in mortgage liquidity left by the collapse of private-sector housing finance since 2008. According to supporters of the FHA’s expansion, its $1 trillion balance sheet represents the difference between the distressed housing market we have and the destroyed one we could have had. To critics, however, the use of the FHA to prop up a downward-spiraling real-estate market has set the stage for an inevitable taxpayer bailout.

President Obama’s budget provides fresh ammunition for the critics. It includes a projection that the FHA will soon exhaust its capital because of mounting losses on its mortgage insurance portfolio, necessitating a $688 million infusion from the U.S. Treasury before Sept. 30.

Officials say that this is a one-time event and that the FHA’s capital cushion is projected to be $8 billion by late 2013. They also note that big banks have agreed to pay the FHA hundreds of millions of dollars as part of the recent out-of-court settlement on alleged mortgage wrong­doing, enough to cover the cost.

But if projections always came true, the FHA would not be facing this predicament. The fact that the FHA needed a bailout, despite assurances that it would not, strikes us as more impressive than the fact that, this one time, the banks will pick up the cost — which, of course, they will pass along to customers elsewhere.

Most of the FHA’s losses are still caused by unusually risky loans that the agency insured before 2009, during the heyday of privately securitized subprime lending — when the FHA was desperate for business. The FHA’s loans since 2009 loans are less risky and therefore more profitable, the agency says. But they are far from risk-free. And federal law requires the FHA to maintain only about a 2 percent capital cushion, as opposed to the 4 percent that private mortgage insurers keep. By conventional measures, the FHA’s trillion-dollar portfolio is leveraged 30 to 1.

The FHA is raising premiums, which should help. Yet it is still in the business of insuring loans up to $729,750, as per a mandate that Congress enacted last year at the behest of the real-estate lobby. In fact, the measure created some incentives for buyers to prefer FHA financing over mortgages backed by Fannie Mae or Freddie Mac: Instead of gradually winding down the FHA’s role in the housing market, Congress ratcheted it up. The administration opposed that law. Now, however, it is unwisely pushing a plan to insure millions of additional home refinancings through the FHA — to be paid for by yet another levy on large banks.

Temporary government rescues have a way of becoming permanent. The history of the FHA (the agency was born in 1934 at the height of the New Deal) teaches that lesson. Yet the price of institutionalizing the FHA’s expanded role could be high, both directly to taxpayers and indirectly through crowding out private-sector entities that could do the same job more efficiently. The longer Congress and the administration wait to return the FHA to its core mission — helping a limited segment of needy home buyers — the higher that price may be.