NCPA - National Center for Policy Analysis

Fixing Mortgage Finance: What to Do with the Federal Housing Administration?

February 13, 2012

The Federal Housing Administration (FHA) insures lenders against the risk of borrower default.  While it does not make loans itself, it sets guidelines for the mortgages it will insure.  Throughout the previous decades and in the buildup to the housing bubble, the FHA played a relatively minor role in the market for mortgages.  However, with the housing bust, the retrenchment of Fannie Mae and Freddie Mac, and the wariness of private lenders toward subprime borrowers, the FHA has become increasingly active, says Mark A. Calabria, the director of financial regulation studies at the Cato Institute.

  • The FHA currently backs an activity portfolio of over $1 trillion.
  • With assets valued at a mere $2.6 billion, the institution is currently operating with a capital ratio of 0.24 percent.
  • With such a highly leveraged position, the FHA is at a high risk of financial insolvency, thereby requiring a taxpayer bailout totaling more than the entire TARP program.

Given its position, the FHA is increasingly viewed with concern, especially with the above-average risk of its loans.  Not only do many of its borrowers have relatively low credit scores, but they also have obtained loans with relatively little money down.  This leaves them vulnerable to housing devaluations that can leave them underwater on their loan obligation.

The characteristics of its borrowers combined with the institution's high-risk strategy leave the FHA's financial solvency in a state of uncertainty.

  • According to the FY2011 Actuarial Review, the net present value of future cash flows from the FHA's current 203(b) book of business is -$26.9 billion.
  • This large liability is not the result of losses from the housing bubble -- values for loans originated in fiscal years 2008 and 2009 alone amount to losses of $7.8billion and $6.6 billion, respectively.

To protect the taxpayer and the broader economy, the FHA should be scaled back immediately, and an emphasis should be placed on improving its credit quality. At the same time, the agency should be placed on a path to ultimately be eliminated, with its risk-taking being transferred back to the private sector.

Source: Mark A. Calabria, "Fixing Mortgage Finance: What to Do with the Federal Housing Administration?" Cato Institute, February 6, 2012.

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