Trump housing plan could have unintended consequences for FHA

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WASHINGTON — In its vision for the future of housing finance, the Trump administration not only calls for smaller footprints for the government-sponsored enterprises Fannie Mae and Freddie Mac. It also foresees a smaller role for the Federal Housing Administration.

Yet many of the ideas outlined for the FHA in a Sept. 5 report by the Department of Housing and Urban Development have raised eyebrows and have some former FHA officials concerned.

The 43-page, presidentially directed report recommends that the FHA refocus on its core mission of catering to lower-income borrowers, leaving other areas of its portfolio for private-market participants. The report also calls for a risk-based pricing system and a higher capital cushion for the agency.

But some worry those goals could come into conflict with each other. For example, some experts say tiered pricing could disadvantage the very first-time homebuyers that HUD says it wants to prioritize.

“This idea of implementing risk-based pricing would produce an outcome that would just simply raise rates to the same borrowers the rest of the paper talks about ... targeting to help the housing system in the country,” said David Stevens, CEO of Mountain Lake Consulting and former FHA commissioner.

Most of the attention in the administration's housing finance plan has focused on the Treasury Department's recommendations for Fannie and Freddie. Yet HUD'S recommendations could also have a major impact on the housing market.

The report seems to indicate that the FHA should not compete with the GSEs. It also discusses modernizing the mortgage insurer's technology and restructuring its organizational hierarchy.

HUD said the FHA's growth in market share during the Obama administration "increased dramatically while its risk profile has degraded and activities beyond serving its mission borrowers expanded."

"FHA should refocus its single-family housing mortgage insurance program on low- and moderate-income families,
including [first-time homebuyers], who cannot affordably access credit through traditional underwriting," the report said. "Doing so will strengthen FHA’s ability to help these borrowers build equity, avoid foreclosure, and protect taxpayers."

Some analysts say a smaller FHA could benefit private mortgage insurers.

"The report discusses the importance of ensuring that the GSEs and FHA have distinct roles," said Jaret Seiberg, an analyst at Cowen Washington Research Group, in research note. "We believe this likely means the shrinking of the FHA program. That should benefit the private mortgage insurers as those low down payment borrowers would likely migrate to the GSEs."

But it is HUD’s proposal to implement risk-based pricing at the FHA that has drawn the most scrutiny.

Unlike Fannie and Freddie and private players in the market, the FHA essentially has a flat pricing system, charging all borrowers the same mortgage insurance premium regardless of their credit score or risk profile. That flat premium has historically served lower-income borrowers who might be charged substantially higher rates commensurate with their risk elsewhere.

Still, HUD recommended that the FHA adopt a tiered pricing system instead of a uniform premium “in order to protect the [Mutual Mortgage Insurance Fund] and ensure it is pricing appropriately for higher-risk loans.” HUD signaled it is particularly interested in lowering exposure to loans with down payment assistance.

But a risk-based pricing system would contradict the FHA’s stated mission of serving low- and moderate-income, first-time homebuyers, and would leave those borrowers without any source of capital or funding to obtain a loan, said Bose George, a managing director at Keefe, Bruyette & Woods.

“In some ways the mission, which they mention a couple of times in the report, is to support the first-time buyer and the lower end of the market, and so tiered pricing would seem to potentially go against that,” he said.

A layered pricing scheme based on risk would also almost guarantee increased rates for minority borrowers whose homeownership rate is already historically low, said Stevens.

“If you go to a risk-based pricing like the GSEs or other private entities have, … it will disrupt the continuity that FHA has been able to provide for decades in giving an opportunity for first-time home buyers to be able to buy a home with a low down payment at a good rate and an interest rate relative to others,” he said.

George said the proposed tiered pricing structure would also contradict another goal HUD laid out in its report: for the FHA to hold more capital.

“If they did change pricing that way, which would essentially mean raising prices to the weaker borrowers, it would potentially reduce the capital that’s going into that part of the market,” he said.

The FHA is required by law to maintain a reserve ratio of at least 2% in its insurance, but HUD said the agency should strive to retain much more capital than statutorily required.

“It is unacceptable for FHA to require a draw on taxpayer funds to sustain its book of business and so FHA should seek to build its capital ratio well above the statutory two percent minimum to ensure that it is able to weather stress events without requiring a taxpayer bailout,” HUD said in its report.

But if the agency were to focus only on lower-income first-time homebuyers, it would make it much more difficult to build a larger capital cushion, said George.

“Generally if they’re shrinking their portfolio, they’re going to shrink their capital levels as well, because the way the FHA capital rules work is it’s the present value of all the future revenues and losses that contribute to capital,” he said.

HUD’s stated goal of returning FHA to its mission of serving riskier first-time borrowers could also have a dangerous effect on the program, said Brian Chappelle, a partner at Potomac Partners and former FHA official.

No one disagrees with that mission. But with flat pricing, lower-risk borrowers help offset losses from higher-risk borrowers. That cross-subsidy is the “cornerstone” of FHA, said Chappelle.

“FHA’s prime market role is to serve those not adequately served by the private sector,” he said. “But the catch is that FHA was founded on insurance principles, and like any insurance program, it’s got to be able to spread its risk to some degree.”

The cross-subsidy is what makes the flat mortgage insurance premium — the foundation of the FHA — work properly, said Stevens.

“One of the values of the cross-subsidy is you get better creditworthy borrowers also into the program which helps subsidize the cost for others in the program,” he said. “It’s a flat price for all. If you limit it only to first-time home borrowers, or those who are mission-only borrowers, you’re probably going to have a lower overall credit profile.”

HUD also suggested that the FHA should examine loans to repeat FHA borrowers to “ensure these mortgage loans are consistent with FHA’s mission.”

Yet Chappelle said loans to repeat borrowers perform much better than loans to first-time homebuyers, and help keep pricing lower for riskier borrowers, said Chappelle.

“If FHA doesn’t get some of those better-quality loans, it’s going to either force FHA to raise their price to the people who really can’t afford to pay a higher price, or it’s going to become a burden to the taxpayer, which I totally agree is a nonstarter,” he said.

Stevens said the unintended consequences of restructuring the FHA could be magnified in an economic downturn.

“We’re messing with something that’s actually one of the bright spots in the economy right now, which is housing,” he said. “And as we head toward a likely slowdown in the economy, tinkering with something that’s working well is only going to exacerbate the outcome.”

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Housing finance reform Affordable housing First time home buyers Capital requirements HUD FHA