Mortgage Madness, Again

The trouble with the Federal Housing Authority's easy-money policies


Watching Washington policymakers in action, I sometimes think they make mistakes because of unrealistic goals, flawed thinking, blind obedience to party, or dubious information. And sometimes I think they make mistakes because they are—how to put this?—clinically insane.

There is no other way to explain what is going on at the Federal Housing Administration, which provides federal guarantees for home mortgages. Given the collapse in real estate prices, the weak economy, and the epidemic of foreclosures, banks are acting with more caution than before. They now commonly require home buyers to make down payments of 20 percent to qualify for a loan. But the FHA often requires only 3.5 percent.

That's the equivalent of playing pool with a guy named Snake, and it's had two predictable effects. The first is that the agency is insuring about four times as many home loans as it did just three years ago. The other is that the number of FHA-approved borrowers who are not repaying their loans is climbing. Since last year, the default rate has jumped by 76 percent.

Another likely consequence looms: you and I eating the losses. A former executive of mortgage giant Fannie Mae told a congressional subcommittee that the FHA "appears destined for a taxpayer bailout in the next 24 to 36 months." Commissioner David Stevens had to assure the subcommittee that it would not need help—well, unless there is a "catastrophic home price decline."

But who says there won't be? It's not as though anyone at the FHA foresaw the housing bubble or the housing bust. Yet now it feels confident betting its $30 billion cash reserve that prices won't fall.

Just a few years ago, after all, everyone assumed that U.S. home values were bound to keep rising. In fact, on average, they have dropped by a third since the peak of the market. If prices can drop by a third, they could certainly drop some more.

That's why many private lenders wouldn't touch a 96.5 percent loan with a 96-foot pole. One dip in the economy, and the house is worth less than the mortgage. That's an invitation for the owner to stop paying, drop the keys in the mailbox, and find a place to rent—an invitation hordes of people have already accepted.

What most foreclosures have in common is that the mortgage holder owes more than the property could sell for. "Not everybody who has negative equity goes into foreclosure, but nearly everybody who goes into foreclosure has negative equity," says Paul Willen, an economist at the Federal Reserve Bank of Boston.

But Stevens sees no reason the agency should raise its down payment requirement to 5 percent. "All that's going to do is retard recovery," he says, by making it harder for people to buy homes.

But guess what? It should be harder for people to buy homes. Making it too easy to buy homes is what caused the foreclosure epidemic, which led to the financial crisis, which helped crater the economy.

Right now, the real estate market is adjusting to the new environment, where Americans are not willing to pay as much because they perceive that when you buy a house, you cannot be certain of making money on the investment and, in fact, may lose your shirt. The FHA's easy-money policy is supposed to prevent that adjustment, and push up prices, by assuring that people who cannot afford the risks of home ownership will be able to buy.

If many of the loans turn into pumpkins, that's OK. House Financial Services Committee Chairman Barney Frank (D-Mass.), actually told The New York Times, "I don't think it's a bad thing that the bad loans occurred. It was an effort to keep prices from falling too fast." In other words, soaring defaults are not a bug. They're a feature.

But as Willen points out, prices didn't rise during the boom because there was reckless lending. There was reckless lending because everyone thought prices would rise. But the FHA imagines that it can cure the problems created by easy credit by promoting more easy credit.

Is it fair to call that approach shortsighted? Imprudent? Economically fallacious? Sure. But mainly, it's just plain crazy.


NEXT: Insurance Risk

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  1. At least he’s pro-pot

    1. So’s Willie Nelson, but what good does it do?

  2. It’s all part of FHA’s very successful war on credit ratings.

  3. Chairman Stem-Gobbler looks bored.

  4. In conjunction with the $8,000 first time home buyer tax credit, many are are paying 0 down. No skin in the game whatsoever! No default risk here.

  5. It’s all good though… FHA loans are “Federally Insured”

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  8. Barney Frank ass-raping America again.

  9. Saw that Barney Frank quote about a week ago. How can anyone say something like that and not be punched in the face by anyone who heard it? It’s disgusting that anyone would support such a policy, but as far as I can tell, the number of Congrescritters that are against it could probably fit in my cubicle.

  10. He is like Rep. Starnes, who said that debt is the indicator of how wealthy a nation is.

    1. *that is, he said that more debt = more wealth

  11. Mortgage madness?

    It’s all good in:



  12. It’s not insane. It’s simply corruption.

  13. Right now, the real estate market is adjusting to the new environment, where Americans are not willing to pay as much because they perceive that when you buy a house, you cannot be certain of making money on the investment and, in fact, may lose your shirt.


    Okay, children, here’s the problem. Your home is not prinarily an investment! Nothing you own is an investment unless you can sell it and buy food with the profits. Your home is where you live.

    If you sell your home, you then have to buy a new place to live. If your home has “appreciated” (gone up in price) so have all the other houses you can replace it with. You end up behind the curve again.

    And a “home equity loan” isn’t “profit” from your home. It’s just another loan, only if you can’t make the payments you lose your house.

    And if government policy is keeping the “value” of your home high enough that you can’t afford it, who the hell is going to be able to purchase it from you so you can buy food?


    1. If you’ve actually reproduced, chances are you need a home that is larger for two to three decades. After the kids are on their own, you can downsize the home to something you actually need for yourself. The difference between the two house sizes generally means you can buy food with the money. This is the seed of the confusion that is “your home is your biggest investment”.

  14. When a home sells for $100,000, the real estate brokers take 6%. The home is worth $94,000 even if it doesn’t decline in value. On day 1, the house is underwater 2.5%.

    1. When a home sells for $100,000, that price is most likely agreed upon after a low-ball offer by the buyer and a high-ball initial sales price by the seller.

      That sales price is based on the appraisal of the home, which is based upon what are called “comps”, that is, comparable properties in the same region that have recently sold.

      That being said, a home that sells for $100,000 would probably appraise for more, especially in the current buyer’s market.

      Also, realtor and broker fees are added to the agreed-upon price (as part of closing costs), which then inflate the total cost of the loan beyond the $100,000 price of the home.

      Sum and total, your analysis is crap…

  15. We just did a 3.5% FHA. The rate was under 4.9%. In the time it would take us to increase to 20% down, we would lose $8000 tax credit and most likely also the historically low rate.

    The note is 30 yr fixed, the house is in a growing, stable, desirable area which has comparatively very affordable housing compared to some areas. We had no bubble here except maybe in the luxury bands.

    If it is not too much house VS income, if the price is not overvalued, and if it isn’t a money pit, then there is no reason not to go 3.5% down when rates are so low.

    And by the way they underwrote the hell out of us. “Full Doc” really means it. I’m surprised they didn’t ask for blood and urine samples.

    And I don’t agree with using the $8,000 to fund closing. We are going to sit on it as an emergency fund, that way if we lose a job we have security on making the mortgage. Also PMI is ridiculously expensive now which has got to mitigate the overall risk.

  16. A basic truth is that nobody has a right to a house. Although all people have a basic personal responsibility and right to seek shelter. That said, some people need to accept they are better of living in an apartment or other rental dwelling and mus discipline themselves to save for a house if that is what they really care about.

  17. Conservatives should stop pointing at Congress and the FHA and so something about hedging their risks. A bill to stop reinsurance will stop lenders from making bets with other people’s money. Home prices would stabilize at a realistic level out of the hands of speculators. Property would no longer be the feeding trough of governments or the magnet for government navigators of eminent domain.

  18. You really skip around with this one. The FHA loan program has been successful for 70+ years, and one can make a case far more compelling that it is a victim of the current crisis far more than a cause.

    If, like the FHA, sub-prime loans required full documentation, rigorous appraisals, and sane underwriting, the whole crisis could have been averted.

    Instead, the FHA was left to rot under the Bush administration, with 1998 loan limits at 2004 prices. This created a vacuum filled by the sub prime monster, creating a domino effect that damaged all sectors.

    To now condemn the FHA ex post facto when the program is left to carry the water in a disasterous economy after the real damage was done by other far more reckless products is obtuse.

  19. 2.5% down, and a 10% tax rebate. People who don’t repay are being paid to take the loan, then mail back the keys when they get bored.

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  21. Your comment about “no skin in the game” for a FHA buyer is on target. FHA allows the down payment and closing cost to be a gift from a family member or anyone you can establish a long term relationship via a simply gift letter. Now the government will throw in another $8,000 to sweeten the deal all under the banner of increasing home sales and stop falling home prices.

    The government was the entity that started this problem when they demanded lenders to make funds available to increase home ownership to 69% from it 1994 level of 62%. They wanted that majority of that 7.00% increase to come from low-mod income and minorities. Simply put to the lenders, lower your lending standards. Need confirmation check the memos from HUD to lenders in 1994 through 2000 and CRA requirements from the FED for banks to expand and operate during that time frame.

    Let us not forget soon after the lenders got their marching orders and lent with lower standard Congress had to forced Fannie and Freddie to purchase these mortgages from the banks when they were unsellable in the open market.

    The best thing that could have happen when this financial crisis started in housing was to get out of the way. Cash for Clunkers taught us that consumer will purchase if the price is right. Yes it would have been painful over the last two years however we would be near the end of this housing crisis instead of looking to mid 2011 for the foreclosures to peak by many in the housing industry.

    FHA should be increasing the down payment while strengthing their lending standards. Instead they will soon be sitting before Congress begging for more of our money which we can’t afford to give.

    Final point my eight year old sons asks me how much is 1 Billion dollars. I told him it will take almost 32 years for him to live 1 billion seconds. American has over 9 billion dollars of debt on the books plus another 40 billion dollars plus of financial obligation off the books. Now is this the time to take the pain and get our country financial house in order, just like every household is currently doing today.

  22. FHA should be increasing the down payment while strengthing their lending standards. Instead they will soon be sitting before Congress begging for more of our money which we can’t afford to give.

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  24. My only point is that if you take the Bible straight, as I’m sure many of Reasons readers do, you will see a lot of the Old Testament stuff as absolutely insane.

  25. FHA should be increasing the down payment while strengthing their lending standards. Instead they will soon be sitting before Congress begging for more of our money which we can’t afford to give.

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