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The Senate Banking Committee held a hearing recently to discuss the Independent Foreclosure Review, the goal of which is to identify borrowers who suffered financial harm because of errors in their foreclosure processing. Congress could have done better by helping families avoid foreclosure in the first place, but how?
Congress should recognize that for the past 37 years the Federal Housing Administration has been the foreclosure leader. Foreclosures used to be rare in the U.S. — even for the FHA. Yet over this period, 3.14 million mostly working-class families — 1 in 8 — who have an FHA-insured loan have seen their American dream end in foreclosure.
This high rate of foreclosure betrays the FHA’s original mission of insuring sustainable loans to first-time and low-income borrowers. Further evidence of the FHA’s terrible fiscal position is seen in Obama’s budget, which has allocated $943 million to bail out the FHA.
Before proposing a bipartisan overhaul, Congress should consider these five myths:Myth 1: The FHA is held to higher capital standards than the private sector.
Today the FHA is insolvent to the tune of at least $31 billion. It has been required to conduct an annual actuarial study covering the next 30 years to accurately project the expected value of its books of accounts. Yet, over the past 20 years, the FHA has batted 0.000 in accuracy. This is because the FHA is required to guess — generally using rosy scenarios — interest rates, house prices, inflation and the program’s current assets, along with future income and losses on its existing $1.1 trillion book of business. This methodology severely underestimates the FHA’s true condition. Any financial institution proposing to calculate its capital in the same manner would be stripped of its charter.Myth 2: The FHA played no role in the housing boom and bust.
Fannie and Freddie played a visible role in pumping the housing bubble and the foreclosures that ensued. Congress’ affordable housing mandate required the government-sponsored enterprises to increase loans to families — earning less than the area’s median income — from 30 to 56 percent. But if the GSEs were the faces of subprime failure, the FHA was the brain, orchestrating programs to expand debt thus setting off a race to the bottom. The FHA took the lead in crafting the National Homeownership Strategy, which urged doing away with down payments. The FHA’s leadership role is evident in statements made in a 2000 Quicken Loans release touting a partnership with the agency:
• “FHA permits borrowers to have a higher debt-to-income ratio than most insurers typically allow.”
• “It is also perfectly acceptable for people with NO established credit to receive a loan with this program.”
When the GSEs imploded in 2008, the FHA quadrupled its guaranteed loans to more than $1 trillion. While proponents of the FHA feel the organization played a countercyclical role, they ignore the FHA’s role in inflating and prolonging the housing bubble.Myth 3: The FHA 30-year mortgage is an indispensable part of the American dream.
For decades, the FHA’s usual loan term was for 20 years. For good reason: it builds equity, and thus safety, much faster. It wasn’t until the late 1970s that the average loan term became a 30–year one.
For borrowers with erratic incomes, or little savings, the 30-year mortgage does not amortize quickly enough to gain the equity needed to protect a family during hard times. This fact alone goes a long way toward explaining the FHA’s 3.14 million foreclosures since 1975.Myth 4: High delinquency rates overstate the problem.
Nearly 1 in 6 FHA borrowers is delinquent today. The FHA claims this isn’t a big problem because borrowers go in and out of delinquency and don’t necessarily lose their homes. This ignores the harm of delinquency. Consumers with a 660-740 FICO score lose an average of 75 points on their credit score with just one new 30-day delinquency. Those lower credit scores add up to higher costs for individual borrowing — and collectively affect entire neighborhoods. That’s why even one missed mortgage payment is a big deal.Myth 5: FHA lending is safe and responsible — it has an 80-year track record.
Even as the FHA helped working-class families achieve homeownership following World War II, it was investigated by the FBI in 1954 for involvement in fraudulent home-improvement schemes. In 1962, Time magazine noted the FHA’s escalating foreclosure rates. In 1973, author Brian D. Boyer chronicled “how the FHA Scandal worked on a day-to-day basis [to destroy neighborhoods] in the big cities of the United States.” In 1998, the late community advocate Gale Cincotta warned Congress about the FHA’s abusive lending practices.
The FHA has been plagued by fraud and mismanagement and has become synonymous with foreclosure. Worse, the FHA’s foreclosures are not evenly distributed. My research found that 9,000 ZIP codes, in working-class neighborhoods, had an average projected foreclosure rate of 15 percent.
Congress needs to change the FHA now: It sets up American families for failure and threatens taxpayers.
Edward J. Pinto, a former executive vice president and chief credit officer for Fannie Mae, is a resident fellow at the American Enterprise Institute.