After the housing bubble burst, the Federal Housing Administration (FHA) rapidly expanded the scope of its mortgage insurance well beyond its traditional mission of helping low-to-moderate income, first-time home buyers. Instead of lending directly to borrowers, the FHA insures mortgages in exchange for a premium, and only pays out the cost of those mortgages when borrowers stop making payments. In response to the massive loss of private liquidity, the FHA gained significant market share at a time when banks stopped lending and home prices were still falling. Congress also raised the FHA’s loan limits in order to provide more liquidity, pushing its lending higher up the income scale. The FHA’s intervention resulted in the most severe delinquency and default rates in the agency’s history. Normally self-funded, FHA is facing the possibility of a first-ever bailout, with some estimates as high as $16.3 billion. Now, as home prices have finally started to rebound, pressure is mounting to resolve the FHA’s fate and limit financial losses.
Unsurprisingly, the debate over reforming the FHA has been polarized. Liberals maintain that home prices would have fallen dramatically had the FHA not stepped in when private mortgage insurers and investors retreated from the market. In their view, the FHA provided an important countercyclical function and any taxpayer funds currently needed to make it whole are well worth paying. Conservatives, however, say that FHA‘s emergency lending made homeownership possible for many people, especially in working class neighborhoods, who could not really afford to buy a house. They see the FHA as blocking the return of private capital, wreaking havoc in economically hard-hit neighborhoods, and promoting risky, government-backed lending at a sizeable risk to taxpayers.
That debate, however, is mostly over the past. The critical question now is what should be done to assure FHA’s solvency, and return it to its original mission. U.S. policymakers must decide on a course of action that averts a taxpayer bailout of the FHA and lowers its loan limits to enable private capital to resume its normal role in mortgage lending.