Tuesday, November 29, 2011

Why I think Raphael Bostic is more likely right about FHA than Joe Gyourko/AEI/WSJ

A healthy debate has taken place between HUD Assistant Secretary Raphael Bostic and Wharton Professor Joe Gyourko on the financial future of FHA.  While FHA is thinly capitalized, Raphael argues that will likely survive, while Joe thinks a large taxpayer finance bailout is looming.  In the interest of full disclosure, I should note that Raphael is a colleague of mine at USC, but Joe invited me to be a visiting faculty member at Wharton for a semester.  I think highly of them and am grateful to them both.

I have two reasons to bet on Raphael's view:

(1)  At the time the dumbest mortgage business was being done, FHA was out of the picture.  While FHA's market share is typically in the neighborhood of 12-15 percent, during the period 2003-2007, its market share ranged from 3.77 to 9.66 percent.    FHA did not lower its underwriting standards to that of the shadow banking sector (a sector that was not subject to the Community Reinvestment Act, by the way) in order to keep market share--the government insurance program was far more disciplined than the private sector.

FHA's market share increased dramatically in 2009 and 2010, in large part because the private sector abandoned the low downpayment market.  In 2010 in particular, FHA gained market share despite raising its prices and tightening its underwriting.    FHA was also ramping up its market share after house prices collapsed.  While house prices have not been robustly rising since late 2008, they have not been falling precipitously either.  One could argue that the private sector has been backward looking, while the public sector has been more forward looking.

(2) The second reason I have is more speculative, and is something that I am currently in the middle of researching, but I want to put it out there as a hypothesis (and a hunch).  I suspect that there is such a thing as "burn-out" in default--if a household goes through a difficult time without defaulting, it becomes decreasingly likely to default.  Part of the reason for this is amortization, but that is a small reason.  More important, people who refuse to default even when their measured characteristics suggest that they should have revealed that they are "different," and in a manner that is unobservable.  

Now again, in the interest of full disclosure, I should note that I did not forecast the size of GSE losses, so maybe I shouldn't be taken that seriously.  But I think my first argument will stand up, and as I do more research, I will know more about the second.

1 comment:

Unknown said...

Your analysis about FHA not being a major player when the majority of "bad" loans were made makes sense. I think you need to look at how significant their role was from 2008-2010 and since in some areas the bottom hasn't been found, I wouldn't feel to confident about that determination. Here's a piece I did back in 2008 about FHA still backing 100% loans.

FHA's No Money Down Loan Program
Friday, April 25, 2008

PAUL KANGAS: The implosion of the sub-prime mortgage market has made 100 percent financing for home loans largely a thing of the past. But the Federal Housing Administration still offers a no money down loan program. As Stephanie Dhue reports, that program is now under fire from the agency itself.

STEPHANIE DHUE, NIGHTLY BUSINESS REPORT CORRESPONDENT: When Beverly Queen first found the house she wanted to call home, she feared the down payment would put ownership out of reach.

BEVERLY QUEEN, HOME OWNER: When she told us how much the people wanted us to put down on the house (INAUDIBLE), my husband and I, we looked at each other and we started laughing, because I'm like, we don't have that kind of money.

DHUE: With a $5,000 down payment assistance gift from the non-profit group Ameridream and an FHA loan, Queen was able to buy the house, plant roots in the community and start building savings. She has now lived in the house for eight years.

QUEEN: By being a home owner, that we have something that we can fall back on once we get older and decide to sell our house.

DHUE: Ameridream and a non-profit called the Nehemiah Corporation are the largest providers of seller-funded down payment assistance for FHA Insured loans. It works like this. A seller makes a charitable donation to a non-profit and in turn that non-profit gives a down payment gift to the buyer. That donation generally comes from the proceeds of the sale of the house. But an increasing number of people who get seller-funded down payment assistance are defaulting on those loans. Mortgage consultant and former HUD official Howard Glaser says the program is being abused.

HOWARD GLASER, FORMER HUD OFFICIAL: It's a well-intentioned program that's turned into a little more than a Federally financed mortgage scam. The victim is often the borrower, who is lured into a home they can't afford by a Federal program.

DHUE: Ann Ashburn heads Ameridream. She says the program is a success.

ANN ASHBURN, PRESIDENT, AMERIDREAM: We've helped one million people become homeowners over the last 10 years. Ninety four percent of those homeowners remain successful. They make their monthly mortgage payments without undue difficulty and they are living the American dream thanks to this program.

DHUE: Still, FHA Commissioner Brian Montgomery says these loans risk bankrupting the agency.

BRIAN MONTGOMERY, FHA COMMISSIONER: Foreclosures on these loans are three times as high as loans for borrowers who make their own down payments.

DHUE: As lenders have tightened mortgage standards, these loans are one of the only ways borrowers can get 100 percent financing. In 2000, seller-assisted down payment loans made up less than 2 percent of FHA insured loans. By 2007, that number has soared to more than 30 percent, raising FHA's risk.

GLASER: The losses on these loans far outweigh any other Federal housing program and indeed jeopardize the very stability of FHA at a time when we need it most. It's the wrong policy at the wrong time.

DHUE: The FHA is now funded by fees it charges on loans. The agency says if it must continue insuring these loans where sellers make the down payment, it will need taxpayer money to keep operating. Stephanie Dhue, NIGHTLY BUSINESS REPORT, Washington.