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Are FHA Mortgages A Subprime Problem?

by Peter G. Miller
November 6th, 2007

It all started with an op-ed piece about the FHA program in The Wall Street Journal by John Berlau, director of the Center for Entrepreneurship at the Competitive Enterprise Institute.

Now it’s a debate with HUD.

Entitled gencon/019,06195.cfm”>The Subprime FHA and published October 15th, Berlau said that “just as financial players are applying more scrutiny to private-sector loans, the elected trustees of the taxpayers’ piggy bank are looking to engage in some real estate speculation of their own by expanding a 73-year-old New Deal edifice: the Federal Housing Administration.”

“The FHA’s recent credit history,” says Berlau, “shows it is far from the prudent institution it is said to be. By its own estimate, next year the agency expects to be in the red, paying out more for defaulted loans than borrowers pay to it in insurance premiums. “‘Because of adverse loan performance,’” the FHA states in its budget submission for 2008, “‘total costs exceed receipts on a present value basis, and therefore would require appropriations . . . to continue operation.’”

Berlau then makes an unusual argument:

“Despite its decreasing market share, the FHA appears to have played a significant role in the current mortgage “meltdown” attributed to subprime loans.

“For the past three years, delinquency rates on the oh-so-safe mortgages insured by the FHA have consistently been higher than even those of the dreaded subprime mortgages. In the last quarter of 2006, for instance, the delinquency rate for subprimes had increased to 13.33% in the National Delinquency Survey compiled by the Mortgage Bankers Association. But in the FHA category, the rate had risen to 13.46% — “‘a new record.’”

Does Berlau’s concern make sense?

Yes, delinquencies are a problem. But delinquencies are not foreclosures and the FHA has an unusually-strong ability to counsel borrowers and to help them avoid the auction block.

Also, some of FHA’s wounds are self-inflicted. At the prodding of the lending community, it changed the caps on ARM products from a 1 percent periodic cap and a 5 percent lifetime cap to 2 percent and 6 percent. The result is that ARM costs now rise at a far-greater pace than under the 1/5 arrangement — and faster-rising caps contribute to delinquencies and foreclosures.

In a response HUD Secretary Alphonso Jackson, says department says that “John Berlau’s article Oct. 15 commentary opposing FHA modernization (“The Subprime FHA”) is incorrect when he tries to pin the “worst excesses” of subprime loans—such as unverified income levels—on the Federal Housing Administration.”

“The FHA requires lenders to underwrite all loans and borrowers to document their credit history and income. Short-term “flipping” of homes is also prohibited, contrary to his claims.”

“A healthy FHA,” says Jackson, “is good medicine for the ailing housing market. It is self-sustaining, costing taxpayers nothing, not “subsidized,” as Mr. Berlau claims. It is safe, with a foreclosure rate half that of risky subprime mortgages. And it is sound, free of costly gimmicks such as “teaser” interest rates or prepayment penalties. It also offers mandatory loss mitigation, meaning that we will work with homebuyers if they get in trouble.”

Hopefully the FHA will take a pro-borrower stance and reverse its ill-conceived caps increase. That would relieve borrowers, Mr. Berlau and claims against the FHA insurance pools.

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