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Brooks Wilson's Economics Blog: Wallison and Pinto on the FHA

Monday, December 20, 2010

Wallison and Pinto on the FHA

There were many factors contributing to the housing bubble, some by the private sector and others public.  One mistake made by the federal government was encouraging loans to unqualified buyers.  The Clinton administration actively worked to lower lending standards for home loans. The administration also imposed mandates on Freddie Mac and Fannie Mae, two government sponsored enterprises, that forced them to purchased subprime loans and mortgage backed securities built from subprime loans.  The Bush administration strengthened the mandates. 

Congress also played a major role, keeping regulation of the GSEs weak and encouraging loans in their districts ignoring risks to the financial sector.  Has the bursting of the financial bubble, financial crisis, and impending fiscal crisis given incentives to lawmakers to act in a more circumspect manner?Peter J. Wallison and Edward J. Pinto offer evidence that Obama administration and lawmakers have learned little in “How the Government Is Creating Another Housing Bubble.”  In part, they write
Since the federal takeover of Fannie and Freddie in 2008, the government-sponsored enterprises’ (GSEs’) regulator has limited their purchases to higher-quality mortgages. Affordable housing requirements Congress adopted in 1992 and the Department of Housing and Urban Development (HUD) administered until 2008 have been relaxed. These had required Fannie and Freddie to buy the low-quality mortgages that ultimately drove them into insolvency and will cause enormous losses for the taxpayers.

The latest regulatory change does not reduce the total losses that taxpayers will suffer from HUD's policies; those losses, estimated at about $400 billion, are baked in the cake. But the higher lending standards now required of Fannie and Freddie should reduce future losses.

Not so for the FHA. While everyone has been watching Fannie and Freddie, the administration has quietly shifted most federal high-risk mortgage initiatives to FHA, the government's original subprime lender. Along with two other federal agencies, FHA now accounts for about 60 percent of all U.S. home purchase mortgage originations. This amounts to more than $1 trillion and is rising rapidly. The administration justifies this policy by saying it is necessary to support the mortgage market, yet borrowers are once again receiving high-risk loans…

The Dodd-Frank Act, however, exempts FHA and other government agencies from appropriate standards on mortgage quality. This will give low-quality mortgages a direct route into the market once again; it will be like putting Fannie and Freddie back in the same business, but with an explicit government guarantee.

For example, thanks to expanded government lending, 60 percent of home purchase loans now have down payments of less than 5 percent, compared to 40 percent at the height of the bubble, and the FHA projects that it will increase its insured loans total to $1.34 trillion by 2013. Indeed, the FHA just announced its intention to push almost half of its home purchase volume into subprime territory by 2014-2017, essentially a guarantee to put taxpayers at risk again.

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