By TOBIAS PETER
Last month, at the behest of the Federal Housing Finance Agency, Fannie Mae and Freddie Mac, the government-sponsored enterprises, announced new risk-based pricing guidelines that loosen mortgage credit for higher-risk loans. Since the Federal Housing Administration traditionally serves higher-risk borrowers, this move represented the latest salvo in a renewed battle for such borrowers.
As a response, FHA is rumored to announce today (2/22/2023) a 30 bps mortgage insurance premium cut that will expose taxpayers and not help prospective homebuyers.
The last time FHFA imposed credit loosening on the GSEs in 2014, FHA responded shortly thereafter in kind with a large 50 bps MIP cut. At the time, FHA predicted that this cut would lead to 250,000 new first-time buyers over the next three years and save each FHA buyer $900 annually. Instead, we found that home prices rose about 2.5 ppts. faster in FHA neighborhoods and only about 17,000 new first-time buyers were brought into the market, far short of FHA’s prediction.[1]
This outcome was entirely predictable. In 2015, the country was already two and a half years into a seller’s market — generally defined as a market with less than a six-month supply of homes for sale at the current selling pace. When the inventory of homes for sale is tight, credit easing cannot bring in many new buyers since there are already too many buyers chasing too few homes.
However, credit easing will cause the surplus of buyers to use their newly minted buying power to bid up the price of houses. This is simple economics and ironically, Ernest Fisher, FHA’s first chief economist already demonstrated this principle using FHA and Veterans Affairs data from the 1940s.
Instead of helping first-time buyers, the beneficiaries of FHA’s 2015 MIP cut were existing homeowners, who profited from higher asset prices, and realtors, who received an estimated windfall of around $2.8 billion due to increased commissions.[2]
While FHA’s loan volume did increase substantially in the first year after the 2015 premium cut, this was largely due to FHA poaching borrowers from sister federal agencies such as Fannie and Freddie, not from a large influx of new first-time buyers.
Largely because there hasn’t been another premium cut since 2015, FHA’s financial reserves, which by law are required to stay above 2%, now stands at 11% — a record level. Yet market conditions are again not favorable to a MIP cut.
Housing supply remains at historically low levels at 4.0 months and is even tighter for entry-level homes. A premium cut would thus get absorbed into higher prices and do little for affordability – just like in 2015.
A MIP cut would amount to a massive wealth transfer from FHA’s capital reserve fund, which ultimately protects taxpayers, to realtors and homeowners in largely FHA neighborhoods. It is more than questionable how such a move “would help as many borrowers as possible” since it has shown that it doesn’t help very many at all.
Rather than cutting the premium on 30-year loans, there are good reasons why FHA should have held on to its reserves. Economists in a recent survey pegged the odds of a recession this year at 64%, which could mean layoffs and delinquent FHA borrowers depleting their financial reserves.
Given this uncertainty, FHA should keep its powder dry. For one, home prices are still at inflated levels due to the Fed’s loose monetary stimulus. Moreover, while the market has strongly corrected in markets such as San Francisco or Seattle, home prices can still decline further, which would spell trouble for FHA borrowers.
Instead of a straight premium cut, a far superior solution would have been for HUD to focus on helping disadvantaged borrowers and neighborhoods reliably grow wealth. This could be done by tying any premium reduction to shorter loan terms, which would reduce defaults, enable borrowers to build wealth, and help stabilize neighborhoods.
Importantly, this approach would not increase buying power during a tight market, thereby mitigating against inflationary price pressures while ensuring more rapid equity buildup by FHA borrowers.
As we have clearly seen in 2015, neither borrowers nor taxpayers win when one arm of the government competes against the other for market share. By cutting its MIP on 30-year term loans, FHA has just ignited another episode of a pointless pricing war with the GSEs.
Sadly, it feels like déjà vu all over.
Footnotes
[1] Davis, Oliner, Peter, and Pinto, The impact of federal housing policy on housing demand and homeownership: Evidence from a quasi-experiment, http://www.aei.org/wp-content/
[2] The increase in commissions from the 2015 cut averaged about $325 per sale. If you multiply that by the over 1.22 million home sales in tracts with high FHA concentration in 2015, you get a windfall of almost $400 million per year. These higher prices have become the higher base upon which future home prices are set. For realtors, the MIP cut is thus a gift that keeps on giving.
Tobias Peter is the assistant director of AEI Housing Center. American Enterprise Institute is located in Washington, DC.