Rethinking the Federal Housing Administration (FDA)
Executive Summary
The Federal Housing Administration (FHA) has failed by any reasonable metric. Not only is its main mortgage insurance guarantee fund insolvent, lacking sufficient capital resources to cover expected losses, but it is also failing many of its intended beneficiaries in helping them achieve sustainable homeownership. These twin financial and policy failures call for a fundamental rethinking of how to better achieve FHA’s mission to assist first-time homebuyers and financially constrained households.
The report argues that phasing out the FHA over a period of years and replacing it with a new subsidized savings program for these households is preferable to attempting to reform the existing FHA structure.
Introduction
The FHA was established in 1934 during the Great Depression to stabilize the housing market. Its current policy focus was set by the National Affordable Housing Act (NAHA) of 1990, which aimed to help first-time homebuyers and financially constrained households without meaningful down payments become successful homeowners. The NAHA envisioned the FHA operating a mortgage insurance guarantee program that would be self-supporting and not require taxpayer bailouts.
Financial and Policy Failures
Recent estimates project cumulative default rates of between 15 and 30 percent among borrowers who purchased homes since 2007, when the FHA began a significant program expansion that more than tripled the size of its mortgage guarantee portfolio. This indicates that sustainable homeownership is not being realized by a large fraction of the buyers whose loans the FHA guarantees.
Moreover, the FHA’s Single-Family Mutual Mortgage Insurance Fund is insolvent. This insolvency might be justifiable if the FHA were successful at helping its target populations achieve sustainable homeownership. However, the combination of financial insolvency and policy failure suggests a need for fundamental change.
Flawed Business Model
The FHA’s financial failure is attributed to its fundamentally flawed business model. Both the FHA and the borrowers whose mortgages it insures are leveraged by more than 30 to 1, a ratio comparable to that employed by Bear Stearns and Lehman Brothers before their collapses. Such a highly leveraged model is unsustainable, especially in a housing market where prices can and do fall.
The FHA’s approach assumes that house values will always rise, an assumption proven false by market realities. This reliance on ever-increasing home prices makes the FHA’s model inherently risky and prone to failure.
Proposed Alternative: Subsidized Savings Program
Given the FHA’s shortcomings, the report proposes replacing it with a new subsidized savings program. This program would provide matches to qualified households’ savings, helping them achieve a 10 percent down payment on the home they wish to purchase.
Benefits of the Proposed Program:
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Simplicity and Transparency: The new program would be straightforward and easy to understand, unlike the complex and opaque FHA system.
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Encouragement of Equity Building: By focusing on saving for a down payment, the program promotes equity building from the outset, reducing the risk of default.
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Promotion of Financial Discipline: The program incentivizes financial discipline and perseverance among potential homeowners.
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Reduced Risk to Taxpayers: With less reliance on high leverage, the program would pose a lower risk to taxpayers.
Conclusion
The FHA’s current model is both financially unsound and ineffective in achieving its policy goals. A fundamental rethinking is necessary to better support first-time and financially constrained homebuyers. Replacing the FHA with a subsidized savings program offers a promising alternative that emphasizes equity building, financial discipline, and reduced risk, ultimately leading to more sustainable homeownership experiences.
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