Is the FHA Fueling a New Housing Bubble?

Some analysts the FHA is re-inflating the housing bubble, but data on the agency's loans may not support that viewpoint.

The Federal Housing Administration has taken a big role in the tight-lending environment of the post-boom housing market, but has it been costly?

That’s the argument of the Fiscal Times, which, in a piece analyzing the financing methods of the FHA, even went so far as to utter the word “bubble” in relation to the lending practices of the government agency.

The situation, as the Times frames it, is one of compensation. In the face of the restrictive lending policies that major banking institutions have followed after the economic downturn, a period where only the most credit-worthy of consumers could apply for loans with significant down payments, the FHA has stepped in to fill the void, offering its low-cost, low-down payment offerings to more modest consumers who lack the stupendous requirements of private lenders.

Those lower standards, the Times argues, has involved extending credit to unqualified buyers, and as a result, the home-owning market has become littered with people of questionable finances that are more susceptible to economic shocks – and thus, delinquencies, defaults and foreclosures.

Roger Staiger, an adjunct faculty member at the Johns Hopkins Carey Business School, said in the article that because of the low down payments, this new breed of homeowners are more like rents.

“You’re creating a country of renters who are now renting from the bank,” he said. “Because of this lack of fiscal prudency (sic), we’re never going to become a nation of non-debtors.”

Edward Pinto, a resident fellow at the American Enterprise Institute, summoned the dreaded “bubble” rhetoric, arguing that the extension of credit to questionable buyers will create uncertainty and risk in the system.

“[The FHA] continues to make loans that are very high risk and they’re not pricing them right,” Pinto said. “There’s no incentive to put down a larger down payment. It makes it difficult for the private sector to compete as they price rationally, as private banks cannot compete with irrational pricing.”

Recent data from the FHA would appear to support the two analysts’ perspectives. As of March, 26 percent of the FHA’s loans from 2007 were seriously delinquent, as were 24 percent from 2008. And, 49 percent of the agency’s modified loans were delinquent again after 12 months, with 638,000 loans total (as of September 2011) in their second default. But as is often the case with government lenders, those numbers are only half the story.

First of all, the delinquency data improves dramatically as time progress. Twenty-four percent of the FHA’s 2008 loans may be seriously delinquent, but that number drops to 11 percent for loans originated in 2009, to 4.1 percent for loans from 2010 and all the way down to 1 percent for loans from last year.

Recent policy tweaks by the FHA have played a big part in that diminishment. In 2010, the agency raised it minimum credit score to 580, along with rising its minimum down payment from 3 to 3.5 percent and limiting seller assistance for down payments from 6 to 3 percent. Then, most notably, it raised its insurance premiums by 75 percent and considered a credit requirement restriction that proved so controversial it all but abandoned the proposal.

Acting FHA Commissioner Carol Galante affirmed the agency’s increased standards in an interview with the Fiscal Times, saying that in a tighter lending environment, the FHA has serviced higher quality borrowers.

“Since the crisis, post-bursting of the bubble, we have seen our borrower profile improve, actually,” Galante said. “The average credit score [for FHA borrowers] is about 700. Pre-crisis it was more in the 640 range.”

Galante also distinguished the loans offered by the FHA and the risky subprime loans that nearly crippled the world’s economy.

“These are fully underwritten … to be a sustainable mortgage in a way that subprime never was,” she explained. “One of the things that happened in the buildup to the crisis, FHA’s market share went from 15 percent to 2 to 3 percent of the market. Private subprime lenders siphoned off FHA borrowers.”

And because of that run-up of bad loans, Galante said, financial institutions have now swung the lending pendulum in the opposite direction, and are now as stingy now as they were altruistic then – and because of that, FHA loans are suddenly attractive for many prospective buyers, a detail we explored in our fall lending issue.

“They have become so risk averse because they got hit so bad by the crisis. They’re perhaps overpricing the risk today to compensate for earlier losses,” Galante said. “People who say we’re under pricing risk? Factually, that doesn’t add up.”

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