As the Federal Housing Administration (FHA) currently holds a negative equity position of $16.3 billion with a capital reserve ratio of -1.44 percent, Congress called on industry experts to discuss FHA’s role in the housing market and possible reforms for the future. The hearing took place Wednesday morning before the House Financial Services Committee.
The overall sentiment from witnesses was that the FHA as it stands is flawed and in need of reform.
When Rep. Lynn Westmoreland (R-Georgia) posed the question of whether FHA would be permitted to function in the private market, Edward Pinto, resident fellow at the American Enterprise Institute, was quick to respond, “Without government guarantee, FHA would be shut down by every state in the country based on capital requirements.”
In his testimony, Pinto argued, “the FHA’s lending practices are inconsistent with its mission and represent a disservice to American working-class families.”
Pinto pointed out about 40 percent of FHA loans harbor at least one subprime characteristic. Either the borrower’s FICO score is below 660 or the loan has a debt ratio of at least 50 percent. “A substantial portion of these loans have an expected failure rate exceeding 10 percent,” Pinto said.
While some argue FHA should reduce its median FICO score from 700 to 660 to assist borrowers who would otherwise not be able to obtain a mortgage, Pinto argues this “higher level of risk-layered loans will result in a substantial increase in expected foreclosure rate.”
Anthony B. Sanders, senior scholar at George Mason University, largely shared Pinto’s views. “The FHA’s book of loans in 2008 has been nothing short of disastrous,” he stated.
Sanders also sees problems in FHA’s current policies. While the GSEs have reduced their conforming loan limits, the FHA increased its conforming loan limit to $729,750.
“When this artificially high conforming loan limit is combined with FHA’s high loan-to-value (LTV) and low credit score policies, we have a recipe for inordinate harm to fragile households,” Sanders said.
Sanders recommended FHA require minimum FICO scores of 660, maximum LTVs of 95 percent, and maximum debt-to-income ratios of 31 percent on all loans it insures.
Loans with lower FICO scores should require a 10 percent down payment, Sanders said.
Julia Gordon, director of housing finance and policy at the Center for American Progress Action Fund, was the FHA’s most stringent defender during the hearing.
Gordon said without the FHA, home construction would have decreased 60 percent more than it did during the crisis, and home prices would have fallen an additional 25 percent, resulting in the loss of 3 million more jobs.
“Critics claim that FHA’s basic business model is flawed. For evidence, they point to a concentration of lending in areas where default rates are high,” Gordon said. “This criticism is essentially blaming the fireman for getting the house wet.”
However, protecting taxpayer dollars remains a concern for many given FHA’s current financial state.
Basil N. Petrou, managing partner at Federal Financial Analytics, Inc., suggested FHA’s “100 percent full-faith-an-credit guarantee” should be abolished and replaced with a limited coverage ranging between 25 and 50 percent. This model is currently in place at the Veterans Administration.
Not only does this model decrease taxpayer risk, but it also holds lenders accountable, Petrou said.
“It is simply impossible for there to be real incentive alignment between mortgage originators and the taxpayer if originators take all the profit and the U.S. taxpayer takes all the risk,” Petrou said.
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