Academic journal article Cityscape

The Public Purpose of FHA

Academic journal article Cityscape

The Public Purpose of FHA

Article excerpt

Abstract

Recent reviews of the Federal Housing Administration's Mutual Mortgage Insurance (MMI) Fund find that the losses on its portfolio are projected to exceed the revenue from its existing insurance policies and its current capital resources. This article places the MMI Fund's "negative economic value" and recent draw on the U.S. Treasury in context and argues that the justification for federal mortgage insurance is the public purpose it serves by filling gaps the private sector leaves, thereby contributing to a healthy and stable housing market.

Introduction

The National Housing Act of 1934 created the Federal Housing Administration (FHA) to help stabilize the economy. In the depths of the Great Depression, up to 1,000 homes were foreclosed on every day, creating distress for American households and financial institutions (Wheelock, 2008). The Mutual Mortgage Insurance (MMI) Fund administered by FHA is supported through premiums that are in proportion to the outstanding loan amount and paid by the borrower. The mortgage insurance, backed by the full faith and credit of the U.S. government, provides coverage for the full amount of the loan. Relieved of the risk of loss in the event of default, lenders can more confidently extend credit at lower prices. FHA also popularized the 30-year, fixed-rate, fully amortizing mortgage that eventually became the staple of the American residential mortgage system. Along with a similar program administered by the Veterans Administration (VA), FHA insurance helped increase the homeownership rate from 43.6 percent in 1940 to 61.9 percent in I960.1

As a public insurance fund, FHA pools risks from where and when conventional mortgage credit is scarce, whether for underserved borrowers, regions, or time periods. For example, geographically uniform premium rates mean borrowers in thriving markets help support households in economically depressed regions. In addition, although each year's book of business is intended to be selfsupporting, mandatory capital reserves in excess of projected losses allow for premiums collected from periods of growth to help compensate for unexpected losses when the market falters. FHA is currently reprising its Great Depression role with an elevated market share symptomatic of the weakness in the private conventional mortgage market. In keeping with its original purpose, FHA has maintained access to credit to stabilize the housing market.

The most recent reviews of FHA's financial position, however, found that the losses on its current portfolio were projected to overwhelm FHA's capital resources (Integrated Financial Engineering, 2012; OMB, 2013). Although FHA has struggled with managing some of its risks, these losses are primarily an indication of the enormous burden FHA has undertaken to stabilize a collapse in the national housing market unprecedented since the Great Depression.

This article outlines the importance of FHA's public purpose in maintaining an adequate supply of mortgage credit through regional and national downturns and provides context for understanding FHA's current financial condition. This article specifically examines so-called "forward" mortgages insured through the MMI Fund, as opposed to Home Equity Conversion Mortgages (HECMs), or "reverse" mortgages, which FHA also insures.2

The Current Financial Health of FHA

The MMI Fund stores its capital resources in two accounts: a financing account equal to projected costs and capital reserves for any remaining funds. With roughly $33 billion available to pay claims, the MMI Fund has enough capital to continue paying claims at the current rate for roughly 7 years. As U.S. Department of Housing and Urban Development (HUD) Secretary Shaun Donovan stated, "[T]his is not a cash problem; it is one of setting the right size of loan loss reserves aside" (Donovan, 2013: 6).

By contrast to cashflow accounting, the economic value of the MMI Fund is defined as the net present value of existing insurance policies, including projected revenue and claims during the life of those loans, and the amount of current capital resources. …

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