- - Monday, May 18, 2015


The liberal narrative regarding the 2008 financial crisis is straightforward.

The wild child that caused all the trouble was the “unbridled” financial industry. Luckily, Fannie Mae and Freddie Mac, the government-sponsored enterprises (GSEs), were somehow able to save the housing industry. (Never mind that the GSEs themselves needed a $200 billion bailout and remain under government control to this day.)

The truth is never this simple, of course. In reality, what caused the crisis was the full spectrum of federal housing finance policy, with its full-tilt push encouraging debt. And smack dab in the middle of that push was the Federal Housing Administration, an agency curiously absent from most narratives about the crisis.

The FHA’s role has been largely ignored by both the right and the left. Perhaps that’s because it required “only” an extra $2 billion in bailouts from taxpayers. But its role — and ongoing problems — deserve attention.

Pundits talk of the FHA’s “traditional mission” of helping first-time homebuyers and low-income individuals. But that’s not its traditional mission. The agency was created in 1934 specifically to boost housing construction jobs.

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By the late 1930s, the FHA (along with Fannie Mae) primarily helped fund large-tract builders and multifamily projects that competed with the Savings and Loans’ single-family homebuilders.

FHA’s homebuyer clientele is far different today, as well.

For example, originally FHA-backed loans were capped at $16,000 — approximately three times the median home price in 1934. (That’s pretty hard to square with a helping-the-little-guy mission.) And those early loans required a 20 percent down payment for a 20-year term. Compare that to today’s federal housing policies, when lawmakers regularly balk at even 5 percent down payments (on 30-year loans).

Despite the terms, FHA (and Veterans Administration) loans were popular during the post-WWII boom, leading people to associate them with increasing homeownership. Research, however, shows that these loans were likely responsible for only a small part of housing growth prior to the 1970s.

From 1949 to 1968, for example, all government-backed mortgages accounted for no more than 6 percent of all mortgages in the market in any given year. And recent studies suggest that FHA-backed loans, at most, have helped some people buy homes sooner than they otherwise would have. In other words, the FHA hasn’t really increased ownership rates.

There’s no doubt that FHA loans have displaced some private lenders, and it’s just as likely they’ve also displaced private mortgage insurance companies.


Unlike the GSEs and private insurers, the FHA provides lenders with 100 percent loss coverage on their loans. That’s more generous than even the Veterans Administration, which typically insures between 25 and 50 percent of a loan.

It’s also a mistake to view the FHA as an insurance company. While its fees (upfront and annual) are called insurance premiums, they amount to nothing more than accounting entries. In reality, the FHA acts nothing like a private insurance company.

A private insurer would invest all those fees so it could pay expected future insurance claims. The FHA does not. All it does is keep track of the fees, so that when they do pay claims, the government can say that they paid out less than they took in.

This cash-payment focus is highly misleading because taxpayers are on the hook for FHA loans no matter what, and FHA premiums have pretty much never been adequately priced to match default risk. Furthermore, the cash-flow focus completely ignores the cost to the economy from displacing private insurance companies.

Over its entire existence, the FHA has contributed to the long-run expansion in federally guaranteed debt, increasing financial risk to both homeowners and taxpayers. And we have virtually nothing to show for it in terms of any real impact on homeownership.

Congress should eliminate the FHA and get the federal government out of the home financing business.

Norbert Michel is a research fellow specializing in financial regulation at The Heritage Foundation’s Roe Institute for Economic Policy Studies.

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