The FHA Reform Act of 2010 was just passed in the House of Representatives last week. The general intent of the bill is to reduce the risk to taxpayers of toxic loans insured by the Federal Housing Administration. From a finance perspective ,there are definite methods that can be used to reduce risk, and there are others that unambiguously do the opposite. Does this bill, sponsored by Maxine Waters (D-CA), do what it purports, or is it another example of the kind of Orwellian double-speak we are all coming to expect from Congress?
The legislation can be viewed on OpenCongress.org. There's a lot of language in the bill that talks to risk management, risk reduction, and applying greater oversight on the mortgage lending process. However, if we read between the lines the story changes...just a little.
Let's address a few key passages:
Amends the National Housing Act to authorize the Secretary of Housing and Urban Development (HUD) to increase the maximum annual premium payments for mortgage insurance, and make the charging of them discretionary instead of mandatory.
Increasing insurance premiums is one certain path to reducing risk - great job Congress! But we should now ask why the "discretionary" term was included? Is this a subtle way of politicizing lending? Will the HUD Secretary skew standards to encourage more subprime lending, while sticking the risk bill on prime borrowers? One thing for sure is that class warfare makes for great politics!
What's worse is that higher fees will not kick in for another 2 years. In the meantime, expect the toxic assets to accumulate without anywhere near sufficient premium income streams to offset the near-guaranteed avalanche of losses.
Authorizes the Secretary to terminate approval of a mortgagee to originate or underwrite single family mortgages if the mortgagee's rate of early defaults and claims is excessive.
Does this paragraph really say anything? Did the HUD Secretary previously not have the authority to limit insuring to excessively risky entities?
Establishes within the Federal Housing Administration (FHA) a Deputy Assistant Secretary for Risk Management and Regulatory Affairs responsible for all matters relating to managing and mitigating the risk to HUD mortgage insurance funds and for ensuring the performance of HUD-insured mortgages. Abolishes the position of the FHA chief risk officer.
Voila! Another bill, another job created...yippy kay yay! We can all rest assured that firing the previous FHA risk officer and replacing him with a "Deputy Assistant Secretary for Risk Management and Regulatory Affairs" will solve the problem. "FHA Risk Officer" just doesn't have enough words in the title to make it a serious position. Xerxes I of Persia long ago realized that titles were everything, calling himself not just by his own name, but "King of Persia and Media, Great King, King of Kings, and King of The World."
If Congress has any hope of solving our chronic trade and current account deficits, Social Security, Medicare, and myriad other financial issues, maybe they should start getting more creative with titles?
Authorizes the Secretary to use outside sources to:
(1) analyze credit risk models and practices employed by HUD in connection with mortgages;
(2) evaluate underwriting standards; and
(3) analyze lender compliance with, and HUD enforcement of, underwriting standards.
Section 7 should be read as "Authorizes the Secretary to give lots of money to private contracting firms like Goldman Sachs, JP Morgan, and BlackStone to do what the FHA should already be doing on its own."
Authorizes appropriations for FY2010-FY2014 to provide additional full-time equivalent positions for HUD, or for entering into necessary contracts, to conduct such reviews, as well as to carry out other responsibilities relating to ensuring the safety and soundness of the Mutual Mortgage Insurance Fund.
More government jobs and more opportunities for private contractors.
Prescribes conditions compelling the Secretary to review and reduce certain cash investment requirements (down payment requirements) binding upon mortgages or mortgagors.
The FHA currently dispenses insurance for mortgages as high as 96.5% loan-to-value, so why in the world would the HUD Secretary need to to further reduce down payment requirements? Let's raise the BS flag here and acknowledge this does nothing other than increase risk for FHA's (i.e. taxpayers) portfolio.
The National Association of Realtors ® (NAR) applauds the bill because it allows the FHA to adjust premiums on mortgage insurance, at least in theory. But we know that the unspoken loophole here is that HUD can now waive, or reduce, premiums at its discretion. NAR lobbied hard for Congress not to increase down payment requirements from 3.5% to 5%, and they are excited about their victory in having that provision stripped from this bill. In NAR's words:
En route to passage, the House defeated an amendment that would have increased the FHA down payment from 3.5 percent to 5 percent, which would have disenfranchised more than 300,000 potential homeowners and would not have contributed significantly to FHA cash reserves.
Why doesn't anyone question whether or not those 300,000 people who cannot afford even 5% down on their mortgage should be buying real estate? Why not rent until they can afford anywhere close to a reasonable down payment? There is no shame in renting! In fact, it makes a lot of sense for most people. This political obsession with universal home ownership is what tore apart our financial system in 2008; why are we perpetuating the same bad policies?
Financial Risk Management Basics:
There are a few ways to reduce financial risk in a mortgage portfolio:
- Increase down payment requirements. Before government started getting involved with real estate loans with FDR in the 1930's, 40% down payments were common. The world has changed since the '30s, but 3.5% down is absurd..the figure should be closer to 20%.
- Increase insurance premiums. Since the FHA is assuming high risk loans with as much as 96.5% loan-to-value they should be charging very high premiums to offset expected losses. Part of this bill authorizes higher premiums to be charged, but then absurdly makes it "discretionary."
- Reduce the volume of assets insured. The more assets the FHA insures the greater its liabilities. FHA is under immense pressure to increase loan volumes to alleviate downward pressures on real estate markets.
What's The Verdict On H.R. 5072, FHA Reform Act of 2010?
Congress is out of touch with reality, and this is clear in the recent passage of the FHA Reform Act of 2010. A sane response to an imbalanced lending portfolio that's inadequately capitalized is to reduce asset exposure, increase quality of assets held, and increase insurance premiums. Those are the only acceptable solutions to reduce risk, everything else is political smoke and mirrors.
Only government workers would think that the best way to reduce risk is to hire more government workers! That's what this bill does. Not only that, but it will open the flood gates for more government contracts with privileged Wall Street consulting firms.
When the House stripped this bill of the 5% down payment requirement, leaving it at 3.5%, they made clear that they are not proposing serious reform. Not only will tax payers be on the hook for more future mortgage losses, but they will be paying more bureaucrats' salaries and fringe benefits to brilliantly manage the increasing losses.
Disclosure: No positions