Lending through the Cycle: The Federal Housing Administration's Evolving Risk in the Primary Market

Article excerpt

Introduction

The Federal Housing Administration's (FHA) two overriding policy directives, access to housing and stability of residential mortgage markets, do not necessarily complement each other (Donovan 2011). Since the collapse of the high-risk mortgage market, the FHA's share of purchase mortgage loans has increased from 4 % of the market in 2005 to over 23 % by June 2010 (HUD 2010). (1) With the FHA serving the counter-cyclical role in regenerating the home mortgage market, it is important to consider how both their role and lending patterns have evolved over the current residential real estate cycle. This paper presents an analysis of the distribution of home purchase mortgages insured by FHA in the primary mortgage market.

According to a report by the U.S. Government Accountability Office (GAO), the general pattern of declining market share for FHA is consistent with the expansion of high-risk loans in submarkets where FHA traditionally served a major role. For example, among minorities, FHA's market share fell 25 percentage points (from 32 % to 7 %) between 2000 and 2006, while conventional prime and subprime shares rose 6 and 24 percentage points, respectively (GAO 2007). The downward trend that saw FHA relegated to a bit role in the larger production has since been reversed, beginning in 2007. Although FHA has not escaped the foreclosure crisis that has overshadowed the mortgage market over the last four years, the rate of FHA defaults remained competitive falling to 4.8 % in the second quarter of 2010. That rate, however, did not hold, nearly doubling to 8.17 % in May of 2011 (FHA 2011). Austerity measures imposed by the FHA on new endorsements in the summer of 2011, such as higher average FICO scores, lower average LTVs, and higher down payment requirements for low FICO borrowers, have been lauded for reducing the average risk factors for newly endorsed loans. As a result, new endorsements were nearly cut in half. As Aragon et al. (2010) and Smith (2011) observe, risk in the FHA portfolio of insured mortgages persists.

FHA's recent credit history indicates there is reason to be cautious about public policies that depend on FHA to support the housing market. The Department of Housing and Urban Development's (HUD) budget for FHA for the year 2008 included a roughly $143 million shortfall stemming from the FHA insurance program. This is the first time in three decades that HUD made a request to Congress for taxpayer support of the FHA (HUD 2007). Furthermore, the Federal Government's overhaul of mortgage markets and financial institutions in general is likely to further increase the exposure and prominence of the FHA and the Mutual Mortgage Insurance Fund. FHA insurance in force has doubled over the past two years and is projected to redouble to $1.5 trillion over the next five (Smith 2010).

Although there have been studies examining the spatial distribution of mortgage types across a city, there is little research directed at FHA in this regard, and even less work that incorporates temporal variation. In the following section, the FHA market share distribution over time is examined with attention to geographic areas with higher economic risk (Karikari et al. 2011). The analysis is conducted on a sample of loans from the State of Florida with zip code level economic/demographic controls and individual mortgage characteristics. Examining association across zip codes provides partial control for risk measures as well as fixed effects that are unique to the neighborhood or submarket. The zip code level analysis allows for isolating neighborhood concentrations of FHA-insured loans. Focusing the analysis on a single state eliminates the need to control for systematic variations in state level public policies that impact mortgage markets. The individual mortgage detail allows for considering the extent of FHA loan risk relative to the total risk of pools of loans originating in the zip code. …