Thursday, October 20, 2011

What Role for FHA in a Recovering Market?

In the second of its assessment reports on the current status and future role of the Federal Housing Administration (FHA), George Washington School of Business professors Robert Van Order and Anthony Yezer, both of the school’s Center for Real Estate and Urban Analysis, looked at what role the agency should play in a recovering U.S. housing market. The report was released in June, focused on current proposals by the Obama Administration to reduce FHA loan limits and is available online.

In their first paper, the writers argued that while FHA, which they describe simply as a government-run mortgage insurance company, responded well to the 2006 housing crisis by becoming the industry’s lender of last resort, that was not the agency’s first mission. Historically, the FHA’s mission has been to serve low-income minorities and first-time homebuyers, which make up a small percentage of the overall market.

With FHA’s current market share at about 25% of all loans made, the agency faces severe risks that the authors say can be avoided if the agency returns to its original mission and reduces its market share to 10-15%.

Earlier this year, the Obama Administration advanced a plan for reforming America’s housing finance market that called for, in part, a decrease in the maximum loan size that can qualify for FHA insurance by first allowing the present increase in those limits to expire. The authors say the Obama plan doesn’t go far enough. In fact, one report suggests that only 3% of the 2010 vintage of FHA-insured loans would have been impacted by the lower loan limits that are set to go back into effect on October 1.

To significantly decrease FHA’s market share, the authors suggest that both the maximum and minimum FHA loan limits should be adjusted downward to meet the real needs of low-income borrowers according to Home Mortgage Disclosure Data (HMDA). An analysis of that data for 2004 indicates that an upper loan limit of $300,000 would meet the needs of 95% of the low-income Black and Hispanic borrowers who took out FHA loans during that year.

The authors fall back on history to strengthen their case, but ultimately conclude that in order to reduce the FHA’s market share down to a sustainable level, the agency must:

• Reduce the minimum loan limit from the current $271,050 down to $200,000;
• Return the FHA loan limit ceiling to 87% of the GSE limit, taking it from $729,750 down to $363,000;
• Return to the use of the current area median home price in calculating the local loan maximum, moving away from the 2008 median home price estimate;
• Reverse the current policy that allows FHA to guarantee loans up to 125% of the median home price in high-cost markets.

Failure to take these actions may not reach the government’s goal of reducing the FHA’s role in the marketplace and could result in increased risk to the agency, according to the authors.

To access the report, click here.

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