Trump's housing plan attacks the FHA mortgage market
Most of the attention of financial markets and policymakers has been focused on the Trump administration's plans for Fannie Mae and Freddie Mac, yet the planned changes for the Federal Housing Administration that were outlined by Hannah Lang last month ("Trump housing plan could have unintended consequences for FHA") are more disturbing. Trouble is that most of the proposals coming from the Trump White House are deliberate and entirely political, and reflect an almost childlike naivete regarding the workings of the housing market.
"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," Lang reports. "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."
As we noted with respect to the proposals to recapitalize and release the government-sponsored enterprises ("Conflict of visions in GSE reform"), the Trump administration’s thinking on housing is filled with conflicts and contradictions, a quilt work of at times irrational proposals that seem to be at odds with the real world of mortgage finance. The radical changes proposed for the government loan program threaten the existence of hundreds of FHA lenders, but may very well get put into effect via nothing more than a rulemaking process.
We've noted that the Trump administration seems to be playing chicken with Congress by proposing some truly sweeping changes in both the GSEs and the FHA. Yet implementing some of the proposals in the Sept. 5 release by the White House on the government loan market could cause serious damage to the housing sector and the U.S. economy. Hopefully the report, which lacks clarity in many respects, will not ultimately be translated into government policy.
First and foremost, the proposal if implemented penalizes the most vulnerable low-income segments of the population, while handing more loan business for high-income households to the largest banks and mortgage insurers. Many loans to low-income households now covered by FHA guarantees will simply not be made at all. By imposing "risk-based pricing" on the government loan market, the Trump administration is essentially turning its back on the very vulnerable populations that the FHA is supposed to help.
In very simplistic terms, here's how the market for FHA loans and Ginnie Mae securities works. Today the FHA stands ready to guarantee any eligible loan for a flat fee without respect to the credit of the obligor. These loans are then pooled with VA and USDA loans, and sold into the secondary market at a premium to back Ginnie Mae securities. This cross-subsidy where loans to stronger obligors essentially support the valuation of loans to weaker borrowers provides issuers with up-front cash, but here's the catch: The issuer must also have the cash capital to fund loan mitigation efforts under FHA rules in the event of default.
By creating a tiered market for FHA loans based upon borrower credit scores, loan-to-value ratios and other traditional ratings criteria, the Trump administration is essentially destroying the economic model that has guided FHA lending for half a century. The proponents of this change argue that the private markets will fill the gap, specifically to accept smaller loans where the investor faces first loss, but the markets suggest otherwise.
While larger banks and investors have shown an appetite for buying prime mortgages above a $500,000 loan amount without a government credit guarantee, there is no viable secondary market for low FICO score, high loan-to-value, relatively small mortgage loans. True, there are a number of specialized issuers in the Ginnie Mae marketplace that originate and service smaller mortgages and loans for manufactured housing, but this is a niche market that will go away if the Trump administration makes the proposed changes.
The Trump administration's plan seeks to "to ensure that FHA and taxpayers are properly compensated for riskier loans." But, in fact, the changes under consideration will destabilize the entire bottom third of the U.S. mortgage market where FHA execution is now the norm.
But there are other surprises in the administration report: "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. Doing so will strengthen FHA's ability to help these borrowers build equity, avoid foreclosure, and protect taxpayers."
In fact, the proposed FHA changes mean that lenders could not refinance a loan in a Ginnie Mae bond portfolio. Only first-time homebuyers would be eligible for FHA loans. Let's say that again. The owner of a Ginnie Mae mortgage servicing right would be prohibited from "recapturing" that borrower into a second FHA loan.
This change would significantly reduce the attractiveness of and liquidity for Ginnie Mae MSRs and likely impose billions of dollars in losses on FHA lenders, both banks and nonbanks alike. Also, such a change would essentially cripple many independent mortgage banks operating in the government loan market. The current value of Ginnie Mae MSRs is about $25 billion today. Cut that number in half if the Trump administration proposal is implemented.
While the Trump administration proposal for the FHA claims that it seeks to strengthen the agency’s capital cushion, in fact the FHA's financial position is steadily improving. The proposal states that "since the financial crisis, risk profile of FHA's portfolio has increased steadily." With the exception of the Home Equity Conversion Mortgage program, the FHA overall is in good shape and getting stronger.
The average credit score of FHA borrowers remains well above pre-crisis levels and net default rates are manageable. Indeed, the current crop of Ginnie Mae servicing assets could become extremely valuable to the owners of mortgage servicing — assuming that the Trump White House does not try to destroy the FHA market in the meantime. The changes made in March of this year to limit cash out refis and require manual underwriting of certain loans with high debt-to-income ratios are further strengthening the program.
The FHA program is crucially important to serving the needs of first-time homebuyers, contrary to the political rhetoric contained in the administration report. Last year, loans to low- and moderate-income borrowers were 57% of FHA originations. First-time homebuyers were 82% of FHA homebuyers and minority homebuyers were 34% of FHA buyers.
Hopefully the Trump administration, with help from industry leaders, will put aside some of the truly radical and unnecessary proposals in the FHA reform plan. Increasing costs to first-time homebuyers in a transparent effort to enrich the largest banks and mortgage insurers will likely cause a decline in mortgage lending volumes. It is a truly bad idea, both politically and in terms of protecting the taxpayer and helping promote growth in the U.S. economy.
The FHA has recovered from the housing crisis of a decade ago. Its fund exceeds capital ratio requirements, serious delinquency rates are at multiyear lows and credit quality remains above historical norms. While the FHA's reverse mortgage program definitely does need to be reformed, overall the FHA is actually performing quite well financially and is essential to helping low-income borrowers. President Trump should declare success at the FHA generally and focus attention on fixing the HECM program.