How to Fix the Federal Housing Administration
June 25, 2013
Current Federal Housing Administration (FHA) policy fails in its mission to help many first-time and financially constrained homebuyers achieve homeownership. To make matters worse, it has failed to remain financially solvent, says Joseph Gyourko, an adjunct scholar at the American Enterprise Institute.
These twin failures underscore the need for bold reforms:
- FHA is a policy failure: Far too many of FHA's intended beneficiaries fail to achieve sustainable homeownership. Recent research projects that between 15 and 30 percent of borrowers whose mortgages FHA has guaranteed since 2007 will default.
- FHA is a financial failure: FHA's main mortgage insurance guarantee fund is underwater. It does not have sufficient funds to cover its expected losses, and its most recent actuarial review puts its net worth at -$13.5 billion. Gyourko's research concludes that FHA needs at least a $50 billion to $100 billion capital infusion to put it on a sound financial footing.
- FHA's business model is fundamentally flawed: Both FHA and the borrowers whose mortgages it insures are leveraged by more than 30 to 1. To be viable, such a highly leveraged business model virtually requires that housing values never fall. As we have learned from the recent housing crash, this is not a realistic expectation.
The appropriate policy to support sustainable homeownership for these households should focus on building equity up front because the prime weakness of the FHA system is the virtual absence of meaningful equity anywhere along its chain of operations.
Phasing out FHA over a period of years and replacing it with a subsidized savings plan would be far better than trying to reform such a flawed program. The replacement program would offer the following benefits:
- The plan would allow qualified households to pay in to a special savings vehicle and receive some type of match from the government. This stands in stark contrast to the current system, which requires a large bureaucracy to price a complex mortgage guarantee and to manage a difficult foreclosure process.
- By incentivizing potential homebuyers to demonstrate financial discipline and long-term planning, this program would help inculcate values that will decrease a household's likelihood of default once it purchases a home.
- Helping riskier borrowers build equity over time will result in a much safer and less leveraged housing finance system. This benefits taxpayers and will result in much better housing outcomes for tens of thousands of borrowers.
Source: Joseph Gyourko, "Rethinking the FHA," American Enterprise Institute, June 20, 2013.
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