November 19, 2011

BEFORE THE housing market meltdown, the Federal Housing Administration was a pokey little agency with a limited mission — insuring mortgages with low down payments for a limited segment of humble but relatively creditworthy home buyers. The idea was to encourage homeownership by directing capital to a low-income market segment that could not attract it otherwise.

Since the crisis, Congress and the last two administrations have used the FHA to prop up housing more broadly, so much so that the agency’s portfolio exceeds $1 trillion and it backs about one of every three purchases of new homes.

Expanding the FHA poses long-term dangers. The agency’s latest independent audit reports it has only $2.6 billion in cash reserves, creating a near-50 percent chance that it will need a bailout if housing prices plunge again next year.

Now is the time to begin unwinding the FHA’s role in the market and “crowd in” private capital. The administration’s white paper on housing finance reform last February backed such a strategy, including a return of the FHA “to its pre-crisis role.” The first step would be legislation that permitted the FHA to insure loans on houses costing up to $729,750 to lapse Oct. 1 as scheduled. Ditto for the temporary hike in the maximum loan eligible for securitization by Fannie Mae and Freddie Mac, which Congress also set at $729,750.

So why did Congress pass a law that extends the higher FHA loan limits, and why did President Obama sign it Friday morning? Well, there’s real estate, and people who sell it, in every congressional district. The real estate lobby, and its supporters in both parties on Capitol Hill, tucked this profoundly unwise measure into a must-pass appropriations bill that included funds to keep the government running through Dec. 16. Administration officials protested, but given the bill’s importance, Mr. Obama did not go to the mat.

Congress did allow the Fannie Mae-Freddie Mac loan limit to revert to $625,500, probably because it would have looked bad to extend it amid all the publicity lately over the entities’ seven-figure executive bonuses. But this is not the concession it may seem. By combining a higher FHA limit with a lower Fannie and Freddie limit, Congress has distorted the market in a new and troubling way. For the first time, the FHA can actually back more expensive loans than Fannie and Freddie can. Those loans will also be riskier than they would have been if done by Fannie and Freddie, since the FHA’s underwriting standards — such as a 3.5 percent minimum down payment — are looser.

“Hypocrisy,” says Sen. Bob Corker (R-Tenn.), who has filed legislation to phase out much of the government’s housing finance role. But that strikes us as a mild description of what’s happening. Congress has turned an agency that used to offer lower-income Americans a helping hand into a subsidy machine for expensive home sales.

This step was not only upside down in terms of distributive justice. It was probably unnecessary, because ultra-low interest rates were slowly drawing creditworthy buyers, and private capital, back into the upper end of the market, according to Guy Cecala, chief executive and publisher of Inside Mortgage Finance. In short, private capital will be crowded out, not in. If Congress can’t wean housing off subsidies now, can it ever?