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.