REQUIRED READING: On Nov. 14, 2011, the Washington, D.C.-based American Enterprise Institute (AEI) published the report ‘Is the FHA the Next Housing Bailout?’ by Dr. Joseph Gyourko, a real estate finance professor at the Wharton School at the University of Pennsylvania. Gyourko's research concluded that the Federal Housing Administration (FHA) was in a ‘precarious’ state due to inefficient capital reserves and a still-unstable housing market, and that it would require capitalization of ‘at least $50 billion, and likely much more, even if the housing markets do not deteriorate unexpectedly.’
Within a week of the report's release, the U.S. Department of Housing and Urban Development (HUD) went on the counteroffensive. In a blog post authored by Raphael Bostic, HUD's assistant secretary for policy development and research, the report was dismissed in uncommonly harsh language. Words such as ‘wrong,’ ‘not true,’ ‘misinformed,’ ‘spurious’ and ‘completely false and irresponsible’ were hurled at Gyourko's research and warnings, and Bostic added that the report ‘completely ignores our reforms to credit policy, risk management, lender enforcement and consumer protections, which collectively represent the most sweeping in FHA history.’
Clearly, Gyourko and Bostic cannot both be correct in their assertions regarding the financial health of the FHA. Or can they? While it is impossible to ignore the FHA's impact in the years following the 2008 economic meltdown, there are still signs present that the agency may be overplaying its hand. And if the hot-button word ‘bailout’ irritates some people, perhaps ‘assistance’ might be a more appropriate way to describe what the FHA will require for the coming months.Â Â Â
For starters, even Gyourko acknowledges that the FHA is not following the example of Fannie Mae and Freddie Mac and operating at a loss.
‘Will they run out of money tomorrow?’ he says. ‘No. But in the next few years, they will need $50 billion to $100 billion to recapitalize their losses over the long run. I think that in the next five to 10 years, the FHA's losses will exceed their income.’
Gyourko's concern is focused primarily on the FHA's actuarial well-being. In his report, Gyourko states that the FHA's Mutual Mortgage Insurance Fund (MMIF) is ‘materially under-reserved by at least $50 billion, with the true figure likely higher.’ Although the FHA has tripled its insurance in force from $305 billion at the end of 2007 to more than $1 trillion through July 2011, the agency has been unable to grow its capital resources at the same pace. The FHA has roughly $30 billion in total liquid capital resources, according to Gyourko.
Gyourko's report also blames the FHA's artificially low default forecast on the administrative decision to downplay a variable that considers the unobserved credit risk of recent mortgage pools.
‘This leads to dramatically lower forecasts of default – on the order of 50 percent for a typical borrower in the FHA insurance pool,’ the report says. ‘No theoretical or empirical foundation for this decision is provided, which effectively implies that there will be no more unobserved high credit risk in the future.’
The FHA's MMIF is congressionally mandated to maintain a 2% capital reserve ratio. However, the agency admits that it is operating far below that level, registering a 0.24% level for fiscal year 2011, down from the 0.50% level of the preceding fiscal year. HUD insisted in a press release that the MMIF will ‘start to rebuild capital in 2012 and return to a level of two percent by 2014 – outpacing last year's prediction.’ Gyourko, however, does not share HUD's optimistic forecast.
‘They have no cushion right now,’ he says. ‘Remember, also, that they are a government agency, and the guideline [on the MMIF] is not a law. The legislation says they need to have a two percent reserve, which they have violated for three years running. Now, they basically have no reserves.’
Gyourko was not alone in his concern – even HUD Secretary Shaun Donovan acknowledged in a Dec. 1, 2011, appearance before the House Financial Services Committee that ‘any worsening of economic conditions in 2012’ that would result in the fraying of the FHA's portfolio by more than $7 billion would require a new cash influx.
‘While the fund has remained positive, we are keenly aware of the importance of remaining vigilant to the risks the agency faces and will continue to take the actions necessary to protect the fund and taxpayers,’ Donovan said, adding that HUD was considering several options, including premium increases in FHA mortgage insurance, to help stave off financial catastrophe.
However, the Republican members of the committee present during Donovan's appearance did not believe that the situation was under control.
‘We see a major red flag here with the decline of the capital ratio,’ said Rep. Shelly Moore Capito, R-W.Va. ‘A bailout of the FHA would be intolerable to the American people.’
‘The FHA is a disaster in the making,’ added Rep. Jeb Hensarling, R-Texas. ‘If we're not careful, it may become Fannie Mae and Freddie Mac, the sequel.’
In December 2011, Sen. David Vitter, R-La., introduced legislation requiring the FHA to recapitalize its MMIF to its congressionally mandated 2% capital reserve ratio within two years.
‘It is their responsibility to manage their funds responsibly and keep their books in order,’ said Vitter in a press statement announcing the legislation. ‘There is no way FHA could operate like that if they were a private bank, and we need to hold them accountable.’
On Jan. 23, the FHA announced additional efforts to ‘protect and strengthen’ the MMIF, including a new requirement that "certain lenders" indemnify HUD for ‘insurance claims paid on mortgages that are found not to meet the agency's guidelines.’ The FHA also stated that it would require ‘all lenders with the authority to insure mortgages on HUD's behalf ('Lender Insurance' mortgagee) to meet stricter performance standards to gain and maintain their approval status.’
How bad is it?
But is this enough to keep the FHA operating without an additional cash infusion?
‘Unless the housing market really rebounds, I think the FHA is in trouble,’ says Les R. Kramsky, general counsel at Florham Park, N.J.-based MLD Mortgage Inc. ‘I believe there is a good chance they will require some sort of bailout by government – I think anywhere between $40 billion and $100 billion, depending on the housing market in the near future.’
Kramsky adds that this year's elections and the increased level of attention being provided to housing policy issues may force the government to hold off any intervention.
‘This could definitely be put off,’ he says. ‘They may do another premium increase to bring up the reserve accounts, as well.’
Gibran Nicholas, chairman of the CMPS Institute, headquartered in Ann Arbor, Mich., points out that the FHA's near-term future will be a reactive response to a difficult market environment.
‘A lot has to do with what happens with the foreclosure situation,’ he says. ‘Obviously, money that the FHA set aside to cover that may not be enough, and it will need a government loan.’
Still, the FHA maintains an uncommonly high level of respect within the mortgage banking industry, and it is difficult to find people who are critical of its operations.
"The FHA has taken a lot of steps to improve the credit quality of the loans they originate," Nicholas continues. "Today, their credit quality is much higher than a few years ago. They are taking the steps necessary to improve their financial state. I do not see this being too much of a cause for concern."Â
‘From our standpoint, the FHA seems to be running fine,’ says John Walsh, president of Milford, Conn.-based Total Mortgage Services. ‘We desperately need the FHA in this market – it is very important that the FHA remain viable and strong. Without their product, it puts a crimp on the purchase market.’
Dan Cutaia, president of capital markets and risk management for Sun Prairie, Wis.-based Fairway Independent Mortgage Corp., praises the FHA for being a source of stability in an unstable economy.
‘They have done very well absorbing quite a bit of market share over the last two years or more,’ he says. ‘During the meltdown, when the mortgage world went crazy, they didn't make any changes to what they did. They avoided a huge bullet.’
And in the event that things take a turn for the worse, there is no evidence that the FHA is going to shut down.
‘The FHA is owned by the government and taxpayers, from first dollar to last,’ says Dr. Robert Van Order, professor of finance and real estate at George Washington University in Washington, D.C. ‘The FHA can get money relatively easy from the government – there is no threat of its going out of business. It is too important to the market.’
‘Besides,’ adds the CMPS Institute's Nicholas, ‘when the government makes a loan to itself, it tends to make a profit.’
However, Gyourko states that his warning against the FHA was not meant to be seen as hostile criticism.
‘It was not an attack on the FHA,’ he says about his AEI report. ‘It is a call for them to recapitalize.’