By Calabria, Mark
USA TODAY , Vol. 141, No. 2810
United States. Federal Housing Administration--Powers and duties
United States. Federal Housing Administration--Finance
Real estate industry--Laws, regulations and rules
Real estate industry--Economic aspects
Real estate industry--Forecasts and trends
Mortgage insurance--Laws, regulations and rules
Mortgage insurance--Economic aspects
THE FEDERAL Housing Administration (FHA), currently contained within the Department of Housing and Urban Development (HUD), insures lenders against the risk of borrower default. The FHA does not make loans itself, but rather sets guidelines for the mortgages it will insure. Mortgages are originated by the lender and either can be held by the lender on its balance sheet or sold to investors or other financial institutions. Payments from the FHA are made directly to the lender and benefit the borrower only insofar as the presence of the FHA either lowers the cost of borrowing or increases the availability of credit.
Lenders pay premiums to the FHA for this insurance, the cost of which is passed along to the borrower. The basic premise is that, by mutualizing default risk across lenders and borrowers, the FHA creates overall efficiencies that offset the premiums that would exist under a purely private system of mortgage insurance.
The FHA currently backs an activity portfolio of more than one trillion dollars. With an economic value of $2,600,000,000, representing a capital ratio of 0.24%, relatively small changes in the performance of the FHA's portfolio could result in significant losses to the taxpayer. As the taxpayer is, by law, obligated for any losses above the FHA's current capital reserves, these are not losses that can be avoided. Reasonably foreseeable changes to the FHA's performance easily could cost taxpayer tens of billions of dollars, surpassing the ultimate cost of the Troubled Asset Relief Program (TARP) bank bailouts.
The FHA did not create the concept of guaranteeing mortgages against default. The first private mortgage insurance company appears to have been the Title and Guarantee Company of Rochester, N.Y., which opened in 1887. By the time of the stock market crash in 1929, some 37 private mortgage insurance companies operated in the state of New York alone.
The initial years of the Great Depression actually saw an increase in the provision of private mortgage insurance. Private mortgage insurers did not begin failing en masse until 1933, in tandem with the wave of bank failures occurring that same year. As nominal house prices were fiat by 1932, with real prices actually rising, the failure of private mortgage insurance appears to have been more the result of high unemployment and the banking crisis rather than stress in the housing market.
The combined failure of the mortgage insurance industry and the reduction of credit availability from some 4,000 bank failures in 1933 led Congress to pass the National Housing Act of 1934, Title II of which created the FHA. This article will focus solely on the FHA's single-family business, generally referred to as its 203(b) program, authorized in Section 203(b) of the National Housing Act, but the agency also provides insurance for multifamily housing (apartments, co-operatives, and condominiums), manufactured housing, and hospitals.
Although FHA requirements were considered quite radical and risky at the time, the agency's initial loan requirements would be viewed as rather stringent under today's standards. At its inception, the FHA required a minimum down payment of 20% with a maximum loan term of 20 years. The FHA also limited its insurance to loans we today would call "prime"--maintaining credit standards that would have excluded borrowers with poor or marginal credit. FHA loans also were required to have an annual interest rate of 5.5%, along with an annual insurance premium of 0.5%. By comparison, private mortgages that were available during that time generally were priced around four percent or 4.5%, making FHA loans a relatively expensive option.
The FHA also attempted to minimize credit losses via restrictions on the properties and neighborhoods that would be eligible. Property quality restrictions were quite extensive, with the agency maintaining an exhaustive handbook detailing various minimum quality standards that would have to be verified via inspection before FHA insurance was written. …