These are tough times for government real estate policy. In December the Securities and Exchange Commission indicted six former executives from the failed government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac, including former Fannie CEO Daniel H. Mudd and former Freddie CEO Richard F. Syron, on charges of fraud, alleging that the GSEs misled investors and the government in statements claiming they had minimal holdings of low-quality and subprime mortgage loans.
Throughout the housing bubble of the late 1990s and early 2000s, Freddie and Fannie, which guarantee mortgage loans and thus provide a substantial interest rate subsidy, had been concealing the large portions of their portfolios consisting of risky investments such as alt-A, subprime, and negative amortization loans. Fannie Mae finally copped to the deception in the third quarter of 2008, long after the housing crash and its attendant recession were in full swing.
Fannie and Freddie (founded in 1938 and 1970, respectively) were quasi-private, government-guaranteed players until 2008, when they were taken over by the Treasury Department. In 2009 Freddie CFO David B. Kellermann hanged himself in the basement of his Vienna, Virginia, home, leaving behind a wife and 6-year-old daughter. In 2010 Fannie and Freddie were delisted from the New York Stock Exchange. In 2011 Sens. John McCain (R-Ariz.) and Orrin Hatch (R-Utah) introduced legislation to dismantle or privatize Fannie and Freddie over five years. The Treasury has slightly reduced the GSEs’ purview, but they still guarantee more than 90 percent of U.S. mortgages.
There is more bad news from the Federal Housing Administration (FHA), which is taking riskier positions in real estate lending just as the rest of the country is looking to reduce indebtedness. Wharton School real estate finance professor Joseph Gyourko warned in a recent study that the FHA, the world’s largest insurer of mortgages, is shaping up as the next likely target for a bailout. (See “Housing Bailout Redux,” page 14.) Gyourko raises three points: The FHA has increased its risk exposure without anything close to a commensurate scaling up of its capital base; it is underestimating future default risk and losses on its single-family mortgage guarantee portfolio by at least $50 billion; and it needs to recapitalize to compensate for these risks.
While the FHA has contested some of Gyourko’s findings, the condition of its books continues to deteriorate. The agency raised its asset base by $400 million in 2011 (and points to this as proof of increased financial health), but it also issued $213 billion in new loan guarantees during the same period. Ed Pinto, a senior fellow at the American Enterprise Institute, calculates that as of last October, 17 percent of FHA-insured loans were in some stage of delinquency. Its “serious” delinquency rate (more than 60 days overdue on loan payments) is more than 9 percent and has been increasing steadily during the last year. More than 836,000 FHA loans, with a total outstanding balance of $117 billion, were 60 or more days delinquent. The FHA is on the hook for 100 percent of its busted loans, and to make things more ominous, it seems to be using older, rosier statistics when calculating its risk.
In November the Obama administration even managed to walk back one of the few things the FHA has done right in recent years: allowing its expanded conforming-loan limit for “high-cost areas” to lapse. Early in the real estate correction FHA upped its conforming loan limit (the mortgage amount that taxpayers guarantee) to $729,750. That emergency increase expired on October 1, when the limit dropped back to $625,500. But this reprieve lasted less than two months: After five straight years of declining house prices, the upper limit is back up to $729,750. Assuming a 20 percent down payment, that puts the government in the odd position of providing a housing subsidy to people living in $1 million homes.
The FHA might hope to escape the consequences of this high-risk behavior if the real estate market were poised for a stunning recovery. That is not the case. Lender Processing Services (LPS), the controversial company that handles about half of all foreclosures in the U.S., reports that the percentage of mortgages in foreclosure is at its highest level ever. “Foreclosure inventories are on the rise,” LPS said in a November report, “reaching an all-time high at the end of October of 4.29 percent of all active mortgages.”
In December the National Association of Realtors (NAR) ended another charade by conceding it had overstated real estate sales for the period from 2007 through 2010. In fact, more than 3 million existing home sales that users of NAR data (including much of the popular press) had been counting never actually happened. For 2010 alone, sales were overstated by nearly 15 percent; the realtors had claimed $100 billion in phantom transactions.
The dire condition of federal real estate bureaucracies may worry those who believe in good government, but for the rest of us it’s hard to get upset about the illness of agencies that are poisonous even when healthy. The GSEs and the assorted agencies of the Department of Housing and Urban Development—of which FHA is just one mischief maker—have created trillions of dollars’ worth of false credit, false wealth, and false sales. Middle- and lower-income Americans have either been priced out of the housing market or nudged into the tyranny of the 30-year mortgage (a financial instrument that would almost certainly not exist if not for government policy). Pro-inflationary real estate policy has enjoyed the overwhelming support of both the ruling parties for decades.
Now that is changing. The threat to federal housing policy is coming not just from the failure of its institutions but from the failure of its logic. Americans who have already taken on homes have in the last year reduced their mortgage debt and are building up equity—a reversal of a three-decade trend in which debt took up an ever-growing share of real estate assets. New homebuyers see prices falling and are willing to wait until houses are affordable for a person of average thrift and ambition. Banks are, after a scandal-plagued delay, beginning to own their bum loans and liquidate foreclosed property; this in turn raises the prospect that the real estate market might hit bottom this decade. These are causes for hope: Despite the planners’ most strenuous efforts, the market still might work.
Tim Cavanaugh is managing editor of reason online.