The Federal Housing Administration, hit by increasing mortgage-related losses, is in danger of seeing its reserves fall below the level demanded by Congress…”They’re probably going to need a bailout at some point because they’re making loans in a riskier environment,” says Edward Pinto, a mortgage-industry consultant and former chief credit officer at Fannie Mae. “…I’ve never seen an entity successfully outrun a situation like this.”
In the past two years, the number of loans insured by the FHA has soared and its market share reached 23% in the second quarter, up from 2.7% in 2006, according to Inside Mortgage Finance. FHA-backed loans outstanding totaled $429 billion in fiscal 2008, a number projected to hit $627 billion this year.
When you find yourself in a hole, stop digging. Except the Bernanke/Summers/Geithner team, who seem to believe you try to dig your way through to the other side of the earth. Call it the Martingale Strategy of government finance.
At this point, even folks in Washington seem able to acknowledge that prices for housing in the middle of the decade, especially in coastal regions and the desert southwest, were so high that families could afford no missteps in servicing the debt. Illness, job loss, divorce – any minor hiccup and there was no room in personal budgets to cushion the blow before delinquency.
To some extent, this problem should solve itself as all bubbles do: at a point in time, the hiccups occur, the houses begin to get foreclosed, and as more houses come available from ever more distressed sellers, people begin to reassess the value of housing. They start to shrink the amount of household income they would like to dedicate to housing, and integrated over the market, that reduces housing prices.
Despite being able to recognize the problem of high housing prices, Serious People in Washington appear unable to understand the necessity of lower housing prices. It is tough to tell if this challenge stems from fear of the difficulty of explaining the concept to the great unwashed or lack of comprehension of the key concept. Or, I suppose, the view that in no circumstances can the money center banks be allowed to fail or get nationalized, enough foreclosures will make their failure evident, therefore housing prices need to be propped up against the economy’s interest because it is in the banks’ interest.
I cannot quite tell, and the economic team has taken Churchill’s advice that in war the truth is so precious it must at all times be accompanied by a bodyguard of lies, so there’s no relying on their statements. That leaves their actions.
Policymakers have used the FHA to stabilize the housing market by pushing it to offer credit with far easier terms than that offered by most private lenders. For example, it will back loans with down payments as low as 3.5%….Before the boom, the FHA wasn’t a big player in the housing business because it didn’t follow private lenders in loosening its standards. Borrowers had to fully document incomes and insured loans were capped at $362,000. Congress increased those limits last year to as high as $729,750 in the most expensive markets.
Would someone explain to me why it is in the economy’s interest to “stabilize” the housing market by encouraging a practice that has proven itself rather harmful? If you get taken to the hospital with a fever of 108F, and after urgent measures are taken begin to cool, they don’t throw you in a sauna when you hit 105F in the name of minimizing the change from the original unsustainable level. They try to get you to a healthy temperature as quickly as possible, and in fact will likely err a bit on the side of overdoing it to make sure there is space to treat any condition that is contributing to the temperature.
While most private lenders have raised lending standards and now require minimum 20% down payments, the share of borrowers who are able to make down payments of less than 10% hasn’t changed in the last two years, largely because of the FHA, says Mr. Pinto, the former credit officer at Fannie Mae.
As I have often mentioned, the 80/20 fixed-rate 30-year mortgage is not the Eleventh Commandment, or even the Twelfth if you are Ronald Reagan. It is simply a postwar American convention. Other developed countries have different standard leverage levels, different duration, different incidence of rate risk – for that matter, different approaches to the tax deductibility of mortgage interest and residential rent – and they do not have greater incidence of homelessness or plagues or any other signs of the Apocalypse. In some cases – many parts of Florida or Las Vegas, for example – a 20% downpayment is probably quite an accommodating lender posture today; a prudent bank would look to something closer to a 30-40% downpayment to absorb future house price losses. In others – the Great Plains, for example – 10-15% down is probably not a big deal.
What should seem ridiculous, however, is spending the better part of two years lecturing bankers about the need to get their balance sheets in order and then counteracting the effect by encouraging a government agency to pick up the role of drunk guy at the craps table. It is profoundly irresponsible to keep inflating new bubbles to cushion the effects of previous bubbles, and simply distressing that none of the many distinguished economists in orbit around the government – Bernanke and Summers, Romer and Goolsbee – feels the obligation to stand up and say enough already, let’s take our losses and move on. I expect Rahm Emanuel to be a scumbag; I keep hoping for better from the grownups.