The House Financial Services Committee’s Subcommittee on Housing and Insurance held its third hearing on the Federal Housing Administration (FHA) recently. Rep. Randy Neugebauer, R-Texas, chaired the hearing and stated that the reason for holding so many hearings is that the FHA is an important agency to the housing finance system, since it insures half of all mortgages in today’s market. Further, it is a government-backed insurance company with $1 trillion book of business that has negative net worth of 1.44 percent, a circumstance that would place a private company in bankruptcy or receivership.
The subject on this day was how the operations of the FHA compare with those of private-sector mortgage insurers. Rep. Michael Capuano, D-Mass., responded that while he agrees with much of what the chairman said, without the FHA the housing bust would have been even more severe, and there would be practically no housing market today. Therefore, he said, if the FHA is out of whack, then it needs to be put back in whack.
Capuano sought to assuage fears that the FHA would require a Treasury bailout by offering a bill, H.R. 1028, that would repeal a requirement that the FHA tap the Treasury under circumstances prescribed under current law. He and the FHA’s management claim that the agency has sufficient cash on hand to obviate the need for a bailout and that its recent business is profitable enough to forestall a bailout in the future.
A panel of private-sector experts was divided as to their assessment of the FHA and its proper role in mortgage finance. Ken Bjurstrom, a principal with Milliman, noted that the mortgage insurance business creates unique exposures to considerable risks from contracts that cannot be cancelled that cover risks that lead to extreme volatility of losses. Against these potential losses, insurers are supposed to “maintain basic disciplines that govern the financial operations including underwriting and ratemaking, loss reserving and high capital commitments.”
The FHA insures 100 percent of losses on the mortgages it insures, whereas private-sector mortgage insurers only cover 25 to 35 percent of losses on each mortgage that defaults. Against this exposure, the FHA lacks the reserves capital that state insurance regulators require private companies to maintain. Whereas private insurers are required to hold 4 percent capital, the FHA’s requirement is only 2 percent, but it actually has a negative capital ratio. Bjurstrom called for the FHA to be “allowed to” establish loan loss reserves and capital ratios similar to those of the private sector.
Bjurstrom was followed by Nat Shapo, a lawyer with Katten Muchin Rosenman and a lecturer in insurance law at University of Chicago who formerly served as insurance commissioner for Illinois. He confirmed the points Bjurstrom made and concluded that the FHA’s Mutual Mortgage Insurance Fund (MMIF) “does not meet its very forgiving risk-to-capital legal standard, and the program has continued to write, and even expanded, its business at a time when it is impaired, insolvent and extraordinarily under-capitalized.”
Shapo charged that “the biggest problem from a regulatory perspective is that the statutory standard has not been enforced in a meaningful way.” He warned that a decision to continue to operate in this manner must be made with an awareness of its consequences.
The third critic of the FHA on the panel, Teresa Bryce Bazemore, president of Radian Guaranty, a private mortgage insurer, listed some advantages the FHA enjoys due to its government support that she contends “crowd out” private capital from the mortgage insurance business. These include the ability to increase guarantee fees charged to Fannie Mae and Freddie Mac and to price its insurance in a manner that makes private mortgage insurance more expensive and steers borrowers to the FHA who could be served by the private market.
Bazemore argued further that pending regulations, such as Basel III capital standards and rules requiring originators of mortgages to retain part of the risk, would confer additional advantages on the FHA to the detriment of private insurers. She elaborated on the arguments of the other critics as to how the enforcement by state regulators of capital and reserve requirements enables the private insurers to cover losses from default.
Bazemore acknowledged that both the FHA and private insurers had loosened their underwriting standards in order to maintain or increase market share. At the height of the housing bust, the FHA increased its market share from 16 percent to 77 percent. She recommended that an arrangement be made for private insurers to share the risk of the FHA insurance and to layer its underwriting on that of the FHA, and that the FHA should concentrate on serving borrowers who would not qualify for private insurance.
The two other panelists generally defended the existing model of the FHA. Brian Chappelle, a partner in the Washington public policy firm Potomac Partners, identified weakness in the purchase of homes by first-time buyers as the biggest problem facing the mortgage market today, due to increased activity on the part of investors who pay cash. He asserted that this trend threatens the ability of people who are not wealthy to purchase homes.
As for the condition of the FHA, Chappelle supported the argument by the FHA that its recent book of business, post-2010, is projected to perform well and that the FHA has straightened out its business model by increasing its premium shares, which also has the effect of making the private insurers more competitive. He also pointed to improved underwriting practices by loan originators as a protection for taxpayers.
Chappelle downplayed the ability of the FHA to insure mortgages in high-cost areas, because they still make up a small share of the total book of business. He criticized private insurers for rescinding as many as 20 percent of their contracts, and he warned that they should not expect their market share to return to pre-bubble levels. Chappelle also faulted lenders who resist following the FHA’s underwriting criteria.
Steve Stelmach, senior vice president of equity research at FBR Capital Markets, a firm that represents investors who participate in the allocation of capital to the mortgage insurance industry, stated that while the FHA has historically crowded private insurers out of the mortgage insurance business, recent changes have encouraged new capital to come into the market, and actions by the FHA to increase its premiums also serve to make private insurance more competitive, as other panelists have said.
He cited a combination of advantages the FHA enjoyed prior to the enactment of reform legislation in 2010 that allowed it to achieve a 90 percent market share. These include premiums set at a single rate regardless of risk, concessions to sellers, looser requirements to buy back defaulted loans and higher margins on loans sold into the secondary market. He concluded that premium increases by the FHA have allowed private capital to come back into the market by causing the FHA to return its focus to borrowers who would not qualify for prime loans.
I have said for years that at any given time, the country is no more than a few years from a crisis in the FHA. Now it is in the middle of such a crisis. The critics on this panel questioned the wisdom of allowing the FHA to bet the company on a housing turnaround, and they pointed out that a private company would not be allowed simply to add its expected gains to it effective capital without posting the reserves and capital that private companies are required to maintain.
There is a good chance that an enormous loss exposure is already baked into this cake. Future hearings and articles may shed light on how the size of this exposure and where it falls.
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