President - Center for Responsible Lending
The Federal Housing Administration is an anchor in our nation’s housing finance system. The program has served as the point of entry for millions of first-time homebuyers in its 80-year history, helping many families climb the opportunity ladder into the middle class. Most recently, FHA played a vital role in the nation’s economic recovery by continuing to insure mortgage loans while private capital retrenched during the housing crisis. Some argue that FHA’s action brought us back from the brink of another Great Depression.
The program, however, is not nearly as effective as it can and should be. One important reason that has generated much deserved discussion lately is the need for further clarification of FHA lender liability under the False Claims Act. That statute imposes triple damages against anyone who submits a false claim to the government, such as a claim for FHA insurance payments. There is still too much uncertainty about what types of errors can trigger that liability, which can result in penalties several times the loan amount. As a result, lenders are understandably wary of making an FHA loan that has even a modest risk of defaulting. This has led to lenders imposing credit overlays on FHA’s standards, and caused many larger lenders to withdraw from FHA lending entirely. This issue, though, is a manifestation of a larger problem that generates many poor outcomes for lenders, consumers, and taxpayers. At the core is a lack of resources that leaves FHA barely holding the operation together, much less being able to proactively address needed improvements. The result is poor for homeowners, lenders, and taxpayers, and it has reached a critical stage.
Since the housing crisis, FHA loan volumes have recovered from the very low levels it had during the boom of private subprime mortgages that displaced FHA lending. In 2015, the most recent data available, FHA provided 20 percent of all home loans1 and 25 percent of home purchase loans. FHA is even more important for borrowers of color, providing nearly half of home purchase loans for African-American (47 percent) and Latino (49 percent) borrowers. Given the growth of these households and their key role in the overall housing market2, FHA’s contribution has been essential. However, there are still too few home purchase loans in both the overall mortgage market and for borrowers of color compared to historic norms prior to the housing boom. In addition, as larger lenders, who are more likely to be targets of FCA action, leave the market, many of the current FHA loans are being provided by smaller lenders, and they require even greater oversight resources due to the increased number of lenders FHA needs to supervise.
This increased loan volume has done much to restore FHA’s capital levels, and its book of business is performing strongly.3 However, due to FHA’s legal structure, this growth has paradoxically worsened FHA’s basic operations. Under FHA’s authorizing statute, all of its revenue goes to the Mutual Mortgage Insurance Fund (MMIF) and cannot be used for operations, even when those expenditures would efficiently improve the soundness of the MMIF. As a result, FHA’s business success has left it stretched to have enough resources to manage its loans. A stark example of this is that FHA’s mortgage systems run on COBOL systems that are so old that it is challenging to secure programmers who can work on them.
This lack of resources thwarts needed actions by FHA across many fronts, including efforts to address lenders’ concerns about False Claims Act liability. FHA attempted to address some of these concerns by devising a system to categorize mortgage defects, which rightly should be the foundation of a system of remedies and penalties for nonconforming loans. However, FHA did not have the resources to implement this so-called taxonomy, and so it sits on the shelf, unused, years later. At a broader level, this lack of resources makes it extremely difficult for FHA to exercise any reasonable quality control system. As a result, the False Claims Act has served in some ways as a substitute for a rational, proportional quality control system. Now, with the presence of the many new smaller, harder to supervise lenders who are rarely large enough to attract False Claims Act review, the challenge of quality control is further exacerbated.
A lack of resources also prevents FHA from pursuing other badly needed reforms that would benefit all constituents. A continuing problem for FHA loans has been the heavy demands of servicing troubled loans. A major challenge for FHA servicers is that they are required to carry the loan during modifications and advance modification expenses. In contrast, the GSEs buy the loans out of the pools during this process, lessening the burden on servicers. The FHA process is costly and risky for servicers, and discourages effective loan modifications, producing bad outcomes for the insurance fund and borrowers. In the current environment of rising interest mortgage rates, this problem will get much worse, as servicers will be less able to provide payment relief and will also be forced to carry the risk of a loan that has a below market rate. The Housing and Economic Recovery Act (HERA) provided the FHA with authorization to buy these loans out of the pools and produce better outcomes, but this too has languished due to the lack of resources to implement it.
FHA made an attempt a few years ago to raise additional funds for these needs, but it met resistance. It proposed legislation authorizing it to assess a 4 basis point ongoing fee on existing and prospective FHA loans. The fee on existing loans would have come out of servicer revenue, and not surprisingly was opposed. Even without this new fee, however, HERA provided for an alternative. HERA authorized $25 million a year for 5 years out of a “negative credit subsidy”- proceeds from the MMIF, to be used for targeted system upgrades and quality control. [HERA sec. 2126] This was conditioned on the FHA’s statutory capital ratio being met, and FHA was below this standard for several years, so this provision was never implemented. This approach is warranted again, as FHA has exceed its required capital standards today.
Meeting the critical need for greater resources at FHA is a key component of reforming not only the False Claims Act uncertainty, but also for enabling the FHA program to operate soundly and implement other badly needed reforms. These targeted expenditures, carefully monitored, would produce substantial net savings for the MMIF – protecting taxpayers, and would materially advance the housing market, opportunities for homeowners, and the overall economy.
The author did not receive financial support from any firm or person for this article or from any firm or person with a financial or political interest in this article. He is currently not an officer, director, or board member of any organization with an interest in this article.
- First-lien, owner-occupied, 1-4 family units including manufactured housing
- http://www.urban.org/research/publication/housing-finance-glance-monthly-chartbook-january-2017/view/full_report, at p. 25