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Too Early to Sound the FHA Alarm

Too Early to Sound the FHA Alarm

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FHA’s immediate financial future is inextricably linked to the health of the housing sector—and the economy as a whole—in the coming years, write Sarah Rosen Wartell and John Griffith.
FHA’s immediate financial future is inextricably linked to the health of the housing sector—and the economy as a whole—in the coming years, write Sarah Rosen Wartell and John Griffith.

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Published by: Center for American Progress on Dec 12, 2011
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1Center for American Progress |  To Early to Sound the FHA Alarm: The Stability in the U.S. Housing Market
 Too Early to Sound the FHA Alarm
 The Federal Housing Administration Is Financially Vulnerable but ItsFuture Depends Most on Stability in the U.S. Housing Market
By Sarah Wartell and John GriffithDecember 12, 2011
Te Federal Housing Adminisraion, or FHA—he governmen morgage insurer hahelps make homeownership aordable o rs-ime homebuyers and lower-incomeamilies—has so ar weahered arguably he wors housing crisis in hisory wihou ax-payer assisance. Tis is a remarkable achievemen a a ime when many oher morgage-invesed nancial insiuions needed governmen bailous.By playing a key counercyclical role, FHA prevened a more devasaing over-correcion inhe housing marke. Wihou FHA hundreds o housands and perhaps millions o home-owners migh no have had access o morgage credi in he wake o he nancial crisis, which would have urher chilled housing demand, depressed home prices, exacerbaed he GreaRecession o 2007-2009, and slowed our already epid economic recovery even more.Buconcern has arisenha FHA could soon run ou o money and require axpayersuppor or he rs ime in is 77-year hisory. While serious, hese concerns shouldno be overblown.Tis issue brie deails he nancial condiion and acuarial projecions or FHAsMuual Morgage Insurance Fund, which backsops all o he agency’s single-amily housing programs, looking specically a conservaive calculaions ha are by any measure overblown when weighed agains more realisic projecions. We hen deail heools available o FHA o deal wih a more severe han expeced housing marke in hecoming years—ools ha could enable he agency o coninue is crucial role in he U.S.housing marke wihou cosing axpayers a dime.
2Center for American Progress |  To Early to Sound the FHA Alarm: The Stability in the U.S. Housing Market
 The current state of FHA
FHA aces signican losses ahead rom loans insured in he years immediaely pre-ceding he nancial crisis, when morgage originaors urned o FHA o susain heir volume as privae acors began o wihdraw rom some marke segmens. FHA’s inde-penden acuariespredicmore han one ou o every our loans insured in 2007 alone will resul in an insurance claim and he 2008 book alone will bring losses o close o$10 billion. For he mos par hese loans were made beore FHA pu in place appropri-ae conrols o sem risks in his new business.Tose loan books also conain a high concenraion o so-called “seller-nanced downpaymen assisance loans,” in which sellers covered he required down paymen a heime o purchase in exchange or inaed purchase prices. Loans wih seller-nanceddown paymen assisance experienced considerably higher claim raes han comparablenonassised loans,accordingo FHA’s acuaries. Tese oen-raudulen assisance pro-grams were laer banned rom FHA insurance programs by he Housing and EconomicRecovery Ac o 2008. While losses rom hese pre-crisis loans will likely coninue or several years, FHA’spos-crisis loan books are expeced o have signican posiive ne economic value,due in par o increased ees and ighened underwriing sandards. Te 2011 book, orexample, is expeced o bolser FHA’s Muual Morgage Insurance Fund’s reserves by $10.5 billion, while he new 2012 book o business is projeced o add anoher $8.1 bil-lion,accordingo he acuarial repor.Sill he capial reserves in he Muual Morgage Insurance Fund are uncomorably low.Te mos closely wached saisic in he acuarial repor is he so-called “capial raio,he amoun o excess cash he agency has on hand o cover unexpeced insurance claims,repored as a percenage o oal insurance-in-orce.FHA is required by law o mainain a capial raio o 2 percen, meaning i has o keep anexra $2 on reserve or every $100 o insurance liabiliy, beyond wha is necessary o coverexpeced claims. Te Muual Morgage Insurance Fund’s curren capial raio is jus 0.24percen, abou an eighh o he legal hreshold, according o he nancial repor.Tis is a big problem bu no one ha should be oversaed. Firs, i’s imporan oundersand wha exacly we’re alking abou here. As required by law, he MuualMorgage Insurance Fund sillholds$29 billion in is so-called “nancing accoun” ocover all expeced insurance claims over he nex 30 years. Te capial raio reecs addi-ional cash reserves o $4.7 billion o cover any unexpeced losses beyond his reserveor expeced losses.
3Center for American Progress |  To Early to Sound the FHA Alarm: The Stability in the U.S. Housing Market
So even when ha raio alls below he 2 percen hreshold, FHA sill has cash on hando cover is immediae insurance liabiliies, based on reasonable expecaions in hemorgage marke. Tink o i as he dierence beween a checking accoun you use opay your bills and a savings accoun you keep ucked away or a rainy day.Bu ha’s no he way some conservaive analyss have presened he daa. Edward Pinoo he American Enerprise Insiue recenly saidha FHA mainains a “$2.55 billionequiy cushion on $1.077 rillion o exposure,” yielding a “422:1 leverage raio.” Pino laercompareshis posiion o ha o he now-deunc Wall Sree invesmen bank LehmanBrohers, which had a leverage raio o abou 30-o-1 beore going under in 2008.Tis analysis is misleading. For sarers Pino ignores he nancing accoun. FHA acu-ally has abou $34 billion on hand o cover abou $1 rillion o insurance-in-orce. Pinoalso seems o conae insurance liabiliies and capial reserves wih nancial “leverage , which radiionally means invesing or lending wih borrowed money. In realiy, FHA’snancial posiioncanno be compared o ha o he big banks beore he crisisbecauseFHA does no hold deb on is balance shee.
Actuarial calculations on the state of FHA
 While he Muual Morgage Insurance Funds capial raio is currenly uncomorably low, here is a reasonable chance i will recover in he coming years wihou axpayersuppor—even i he curren malaise in he housing marke coninues. More han any-hing else, FHA’s solvency depends on he exen o which housing prices coninue oall or rebound in he nex hree years.Like mos privae insurers, FHA’s perormance is heavily dependen on he healh o hesecor i insures. When home prices all, borrowers who suer unemploymen or ohereconomic shocks are more likely o deaul on heir morgages and FHA also recoversless in he even o a deaul. Boh acors resul in bigger losses or FHA.FHA’s acuariesprediche raio will reurn o he required 2-percen hreshold by 2014,assuming a 5.6 percen all in house prices in 2011 and a sligh rebound in subsequen years. Te prediced recovery is atribuable o he high expeced economic value o he2010–2012 loan books o business. (see Figure 1 on nex page)

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