The Federal Housing Administration's Poor Loan Making

April 12, 2013

For the first time in many months, news from the housing market gives investors and home buyers a reason to be hopeful. House prices are finally rising and the share of seriously delinquent loans is down. However, an examination of the Federal Housing Administration (FHA) reveals that the public agency has toxic assets and taxpayers may be on the hook, says Joseph Gyourko, an adjunct scholar at the American Enterprise Institute.

  • The FHA's share of loans in serious delinquency has risen by 6 percent since 2011 and 12 percent of all FHA-insured mortgages in serious delinquency in 2012 were originated after 2010 -- three years after the housing bubble burst because of subprime mortgages.
  • More than 8.5 percent of FHA mortgages are seriously delinquent, which is 3 percent more than the number of seriously delinquent prime mortgages.
  • While 16 percent of all loans made between 2008 and 2009 are seriously delinquent, more than 45 percent of FHA loans from that time period fall into that category.

The FHA's book of business is constantly overvalued. In 2010, its book of business was estimated at a positive $5.7 billion dollars, an estimate that fell to negative $1.1 billion in its 2011 actuarial review and even lower to negative $4.3 billion in its latest 2012 review.

  • The FHA loans are defaulting at such a high rate because the FHA refused to acknowledge the risk of a borrower becoming unemployed.
  • The newly unemployed in the current economy are now staying unemployed for longer periods of time and the FHA only in 2013 started accounting for unemployment risk.
  • In its new assessment, the FHA estimates the probability of an individual becoming unemployed is 100 times less than the actual probability.

The most powerful predictor of loan default is unemployment risk but FHA's initial refusal to evaluate and its current undervalued risk means that the public agency cannot correctly forecast losses on its insurance fund.

  • The risky loan making of the FHA encourages small down payments to unqualified borrowers who have little savings to ride out a spell of unemployment.
  • The FHA must account for the risk of these borrowers defaulting on their loans.
  • In the worst case scenario, the FHA needs a $50 billion to $100 billion in taxpayer bailouts.

Source: Joseph Gyourko, "Unfounded Optimism: The Danger of FHA's Mispriced Unemployment Risk," American Enterprise Institute, April 8, 2013.

 

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