Rethinking the FHA

Article Highlights

  • FHA's most recent actuarial review puts its net worth at a -$13.5 billion.

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  • Between 15 and 30 percent of borrowers whose mortgages FHA has guaranteed since 2007 will default.

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  • If FHA were phased out, an ideal replacement plan should offer the benefits of simplicity, transparency, and sustainability.

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Key Findings

Current Federal Housing Administration (FHA) policy fails in its mission to help many first-time and financially constrained homebuyers achieve homeownership. To make matters worse, it has failed to remain financially solvent. These twin failures underscore the need for bold reforms:

  • FHA is a policy failure: Far too many of FHA’s intended beneficiaries fail to achieve sustainable homeownership. Recent research projects that between 15 and 30 percent of borrowers whose mortgages FHA has guaranteed since 2007 will default.
  • FHA is a financial failure: FHA’s main mortgage insurance guarantee fund is under water. It does not have sufficient funds to cover its expected losses, and its most recent actuarial review puts its net worth at a –$13.5 billion. My research concludes that FHA needs at least a $50 to $100 billion capital infusion to put it on a sound financial footing.
  • FHA’s business model is fundamentally flawed: Both FHA and the borrowers whose mortgages it insures are leveraged by more than 30 to 1. To be viable, such a highly leveraged business model virtually requires that housing values never fall. As we have learned from the recent housing crash, this is not a realistic expectation.

 

How to Reform FHA

Replace FHA with a New Subsidized Savings Plan. Phasing out FHA over a period of years and replacing it would be far better than trying to reform such a flawed program. The replacement program would offer the following
benefits:

  • Simplicity: This straightforward plan would allow qualified households to pay in to a special savings vehicle and receive some type of match from the government. This stands in stark contrast to the current system, which requires a large bureaucracy to price a complex mortgage guarantee and to manage a difficult foreclosure process. The funds would accumulate on a tax-free basis until they were large enough to provide a 10 percent down payment on a home.
  • Transparency: Focusing on borrowers helps ensure that program benefits accrue to the targeted households—not to politicians or private actors such as housing financiers, realtors, or builders. Policy should subsidize those households directly rather than indirectly through an opaque mortgage insurance guarantee. Because costs would not be hidden (as those for Fannie Mae and Freddie Mac were), policymakers could more appropriately balance costs and benefits.
  •  Sustainability: By incentivizing potential homebuyers to demonstrate financial discipline and long-term planning, this program would help inculcate values that will decrease a household’s likelihood of default once it purchases a home. And because the household will have developed meaningful equity in a home before purchase, it will be less vulnerable to fluctuations in the housing market.
  • Safety: Helping riskier borrowers build equity over time will result in a much safer and less leveraged housing finance system. This benefits taxpayers and will result in much better housing outcomes for tens of thousandsof borrowers.

 

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About the Author

 

Joseph
Gyourko

  • Joseph Gyourko is the Martin Bucksbaum Professor of Real Estate, Finance and Business & Public Policy at The Wharton School of the University of Pennsylvania.  He also serves as Director of the Zell/Lurie Real Estate Center at Wharton and is Chair of the Real Estate Department.  Professor Gyourko received his B.A. from Duke University and a Ph.D. in economics from the University of Chicago.  His research interests include real estate finance and investments, urban economics, and housing markets.  Professor Gyourko is a Research Associate of the National Bureau of Economic Research (NBER) and is Co-Director of the NBER Project on Housing Markets and the Financial Crisis.  A former editor of Real Estate Economics, Professor Gyourko presently serves on various journal editorial boards.  Professor Gyourko is a past Trustee of the Urban Land Institute (ULI) and currently serves on the Board of Directors of the Pension Real Estate Association (PREA).  Finally, he consults and advises real estate various companies and investors.


     

  • Email: gyourko@wharton.upenn.edu
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