Raising FHA's Game

Eighth in a series

The last few weeks of congressional hearings regarding the Federal Housing Administration's underwater insurance fund underscore the divergence in opinion over the role of the federal government in housing finance. 

Adding fuel to the controversy, the Government Accountability Office has weighed in with a new report calling out the FHA's situation as high-risk and deserving of policy action.  Significant changes are needed to strengthen, not eviscerate the agency that has provided access to credit markets to millions of homeowners during all economic cycles, including the financial crisis of 2008-9.  From a public policy perspective there may be a way to turn the Mutual Mortgage Insurance Fund issue into a long-term positive by establishing a new independent government housing corporation as a major step toward comprehensive housing finance reform.

During a period of heightened sensitivity over big government's role in markets, the FHA's expanded share of the mortgage market has been a lightning-rod issue.  However, like it or not, the FHA may have averted an even steeper decline in housing prices and higher mortgage rates had it not stepped in during the crisis when private capital evaporated from the market.  Recent congressional testimony by Julia Gordon from the Center for American Progress Action Fund highlights analysis by Moody's Analytics estimating that home prices would likely have fallen another 25% beyond their lowest levels and mortgage rates would have doubled had the FHA not surged in when it did.  We may debate the magnitude of these figures, but the point is clear: the FHA provides a critical countercyclical role that limits economic and social damage when markets implode. 

The FHA, as noted in an earlier GAO report, has been plagued with a chronic underinvestment in resources, particularly in risk management.  While there are so many contributing factors to the MMI Fund's problem, including an unprecedented housing decline, the resource drought at FHA is significant.  As a part of the Department of Housing and Urban Development, it is at a competitive disadvantage in recruiting top talent compared to the banking regulatory agencies, which are on a higher pay scale. The FHA also lacks the pricing analytics and portfolio valuation technologies that are industry best practices for institutions with portfolios as large and complex as the MMI Fund.

One solution to the current situation at FHA would be to establish an independent and self-funded Federal Housing Finance Corp. with a commission structure like the FDIC's, but made up of heads of critical federal housing agencies such as HUD, the Federal Housing Finance Agency, the Consumer Financial Protection Bureau, and the Office of the Comptroller of the Currency, and overseen by a special inspector general's office. Such a structure would ensure federally guaranteed housing programs have the resources needed to manage such programs, and provide a mechanism for creating more effective countercyclical outcomes in times of crisis and stability. Having a commission would allow more stakeholders to have a voice into the strategic direction of the agency.

The primary responsibility of this FHFC would be to determine actuarially fair fees for the federally insured segment of the housing market now served by the FHA and to manage the federal insurance fund (the successor to today's MMI).  Another critical function of the FHFC would be coordinating and facilitating the development of an active and broad market for credit enhancements which would include private mortgage insurance companies and other potential investors.  As part of that job, the corporation would be responsible for pricing a catastrophic reinsurance fee for non-federally insured mortgage securities in a post-Fannie and Freddie market. The concept of such a catastrophic guarantee is outlined in the Treasury's housing finance reform proposal as Option 3, and echoed in the recent report of the Bipartisan Policy Center. The coverage would be triggered only after shareholders of private guarantors have been totally wiped out. This would provide a part of the critical infrastructure needed to facilitate private investment in mortgage markets again. 

The corporation would also be responsible for developing and modifying the Qualified Mortgage and Qualified Residential Mortgage standards (currently the CFPB's job) as well as setting seller and servicer qualification standards for all loans that obtain a federal guarantee. These pricing and policy responsibilities would enable the corporation to take decisive action to scale up during an emergency and systematically scale down when conditions stabilize. 

All of these activities require a level of sophisticated risk management practices beyond the capabilities of today's FHA due to its status inside HUD.  Funded by assessment fees (as a general and administrative portion of its guarantee fees), the new organization could recruit from existing FHA staff as well as Fannie Mae and Freddie Mac as these agencies are wound down.  However, the new corporation would maintain a close relationship with HUD via the commission structure and hence a focus on affordable housing while ensuring appropriate pricing, policy and portfolio management capabilities are in place.  Just as the often conflicting twin missions of the GSEs (profit maximization and affordable housing) contributed to their demise, the dual mission of affordable housing and maintaining stability in the MMI Fund requires a different approach.

Next: Multifamily finance reform.

Clifford V. Rossi is the Executive-in-Residence and Tyser Teaching Fellow at the Robert H. Smith School of Business at the University of Maryland.