The new National Mortgage Risk Index finds that overall, 10.9% of mortgages backed by the FHA or purchased by either Fannie Mae or Freddie Mac would go into default over the next five years if an economic crisis similar to the 2008 debacle would strike the country.
But a whopping 23.2% of all FHA loans would falter, as opposed to just 5.6% of loans bought by mortgage giants Fannie and Freddie, according to the new index.
The new NMRI bechmark was developed primarily by Edward Pinto, a resident fellow at the American Enterprise Institute, and Stephen Oliner, a resident scholar at the conservative think tank. It was developed under the aegis of AEI’s new International Center on Housing Risk.
Pinto, who has been a thorn in the side of the FHA, Fannie Mae and Freddie Mac, says the NMRI is "a transparent and objective measure" of mortgage risk, home-price risk and the capital adequacy needed to evaluate and manage housing risk.
"The numbers aren't conservative or liberal," Pinto says. "How people use the numbers can be done through the lens of political orientation, but not the numbers themselves."
During a media briefing, Pinto and Oliner, who is co-director of the ICHR, said the index will help investors, lenders, policymakers and even consumers assess and mitigate their mortgage and housing risks.
The recent financial crisis stemmed largely from the failure to understand the build-up of housing risk, they say, but better information can help dampen the boom-bust cycle and make corrections less damaging.
The authors say mortgages should be evaluated in the way cars are tested for their crashworthiness. They should be put to a stress test of a substantial drop in prices, Pinto says.
The index uses 1990 vintage loans as a benchmark—“a time when a preponderance of loans were considered safe”—as well as 2006-07 vintages when lending standards were lax.
And measured against those standards, the index finds that fewer than half of all loans originated between Aug. 13 and Oct. 13 can be considered low risk, which is defined as a default rate of less than 6%. More than 30% are high risk, defined as a default rate of 12% or more, and roughly 22% are medium risk.
FHA's share of lower-risk mortgages, moreover, is less than 1%. And Fannie Mae's share of higher-risk loans is growing, Pinto says. "Fannie Mae is adopting a higher-risk profile and taking business away from Freddie. It is willing to accept riskier loans."
The authors say that while the government has attempted to curb perceived risk factors, common-sense credit standards have yet to be adopted. And without such measures, they argued, housing markets will remain vulnerable to what caused the last collapse—the gradual abandonment of sound underwriting standards.
The center also plans to introduce new indices of collateral risk and capital adequacy, and its some two dozen international members are working on similar risk profiles for their own countries.
Working with Pinto and Oliner on the project are Morris Davis, academic director of the Graaskamp Center for Real Estate at the University of Wisconsin and a visiting AEI scholar, and economist Michael Molesky, a leading expert on mortgage default risk and insurance regulation.
Lew Sichelman is an independent journalist who has been covering the housing and mortgage markets for more than 40 years.