Last Friday, in one of its very first acts, the Trump Administration called an indefinite timeout on a recently enacted decision to lower monthly FHA mortgage insurance rates for new borrowers from .85% to .60% or 25 basis points. The order was issued on January 9th under then President Obama, and was scheduled to take effect on January 27th under President Trump. Borrowers were notified by their lenders of the impending rate change, and so quite rationally began to put off their closings.
To accommodate the new rate, in addition to notifying their customers, lenders nationwide were forced to enact a slew of changes in their paperwork and procedures. This was required without much notice and at great cost, all sides knowing full well that the banks would quite possibly have to unwind everything at 12:01pm on January 20th.
It is possible that the rate change could have gone unnoticed in the infancy of the new Administration had it not been revealed during the confirmation hearings for Dr. Ben Carson, Trump’s nominee for the director of HUD, the FHA’s parent organization. Clearly Carson was unaware of the rate cut when questioned, but he promised to look into the matter to see if it was justified in a rising interest rate environment. (Mortgage rates have increased .66% since the November election.)
The cut was based upon the fact that the FHA has exceeded its reserve requirements two years in a row. But a scant eight years after the housing crisis, there is no guarantee that another crisis will not ensue and erase those gains. Moreover, the FHA’s role in the housing market has expanded. When conventional lending cratered after 2008, FHA guaranteed mortgages went from 2% of the total to about 1 in 6 of all new mortgages in the US. By mid-2015, the FHA had guaranteed $1.3 trillion in mortgage debt.
Once alerted during the hearings someone on the transition team did look into the rate cut and it was suspended Friday. Those searching for signs that President Trump was going to preach but not put into practice his promise to look after the interests of poorer Americans framed the action as proof that once in office he would ignore less-affluent Americans. The reality is not that simple, and the dynamic between stakeholders and consumers who pay for mortgage insurance bears closer economic analysis. Programs that once served a great and beneficial purpose don’t always do so in perpetuity.
The original intent of mortgage insurance issued by the Federal government appears glancingly similar to FDIC guarantees-systemic financial stability. However, deposit insurance is paid for by banks, and is intended to give comfort to consumers. Mortgage insurance is designed to allow banks and increasingly non-bank lenders to offer mortgages to buyers who might not otherwise qualify. It is paid for by borrowers, through an upfront payment of 1.75% and monthly premiums. FHA mortgage lenders accept lower credit scores and down payments as small as 3.5%. It is more forgiving of bankruptcies and allows families to own in some locations for less money than they could rent.
During the Great Financial Crisis, FDIC coverage increased from $100,000 to $250,000. Sheila Bair, its director at the time, was widely seen as a hero and skilled negotiator. The FHA however did not fare as well, and burdened with an unprecedented number of defaulted mortgages eventually had to be bailed out by the federal government. According to Andrew Khouri at the Los Angeles Times, during Carson’s hearing "Some Republicans expressed concern that the rate cut could cost taxpayers if the loans started to go sour and the FHA was unable to cover the losses. The agency need a $1.7 B bailout from the U.S. Treasury in 2013 after it expanded its role last decade after the collapse of the subprime mortgage market.”
The key question is moral hazard. It is one thing to protect savers from bank failure. But the FHA protects lenders based upon the premise that borrowers with fewer assets and/or weaker credit will benefit if they are able to buy houses. The borrowers pay to protect lenders and this is not cheap- it adds nearly a point to their monthly mortgage costs that wealthier or more creditworthy buyers do not bear.
When lenders know that if they make a credit mistake, their losses will be covered, what will ensure against reckless behavior? Why insert a government agency when the banks themselves could simply charge higher rates for less-creditworthy customers, streamlining their credit procedures and cutting out the FHA, to benefit themselves and their shareholders? Private mortgage insurers do exist and perhaps are better suited or incentivized to gauge market risk.
Change is probably on the way. Congressman Jeb Hensarling (R Texas) the highly influential chair of the House Financial Services committee passed the Protecting American Taxpayers and Homeowners Act (PATH) which would “increase competition by ending the federal government’s domination of the housing finance market that has left taxpayers liable for $5.1 trillion in mortgage guarantees.”
Pushing the pause button, even if it prevents short term relief for some, might result in a better, fairer system than the one we currently have to assist consumers on the lower rungs of the housing market. American housing matters not just for the US economy, as we learned in 2008, but for the whole world.