Housing agency’s woes offer chance to fix mortgage market

For the first time in its 78-year history, the Federal Housing Administration might need a government bailout.

The agency’s most recent audit, released last week, reveals it is burdened by a $16.3 billion deficit in the value of its insurance fund, primarily on loans it backed ahead of the housing market’s collapse. The audit also reveals — or should remind us — that the federal government’s role in the mortgage market is outsized and should be reduced.

The FHA’s troubles are largely a result of the housing party hangover, including defaults from a questionable program that allowed sellers to cover the down payment on behalf of buyers, often by inflating the price of the home.

Congress wisely banned such loans beginning in 2009, and since then the FHA has steadily improved the credit quality of the mortgages it insures, with an average credit score of 698 in 2012. The agency’s total delinquency rate is at its lowest quarterly level since 2005, according to an analysis by bank consultant Potomac Partners. The agency has taken other steps to improve its finances. It is raising the annual premiums it charges borrowers to insure mortgages — and it plans to sell 10,000 delinquent loans a quarter.

Yet troubles remain. The Depression-era agency has strayed from its original mission of helping low-income and first-time homebuyers. Thanks to previous approval from Congress, the FHA is allowed to back loans of as much as $729,750 in some areas. Its market share has ballooned to about 30 percent, and it insures a loan portfolio of about $1.1 trillion.

The FHA’s market presence has increased in large part to fill the vacuum created by the retreat of private capital after the housing bust. The FHA, Fannie Mae and Freddie Mac, the two government-sponsored mortgage operations, now back more than 90 percent of all new mortgages. That support has girded the housing market, insulating the U.S. economy from an even worse downturn. It has also discouraged private capital from getting off the sidelines.

Luckily, the housing market appears stronger by the day, making possible the gradual withdrawal of government support. The most recent data show the rate of seriously delinquent U.S. mortgages has fallen to the lowest level since 2008. Home prices continue to stabilize, jumping 5 percent in September from a year earlier — the biggest increase since July 2006, according to CoreLogic Inc.

Eventually, the FHA should return to its original role as a provider of mortgage credit for low and moderate-income borrowers. This can be accomplished in part by slowly decreasing the size of the maximum loan that the FHA insures while continuing to raise the price for FHA mortgage insurance to help cover any expected losses. The government should also consider raising the minimum 3.5 percent down payment to 5 percent or more, because research shows that mortgages with larger down payments are less likely to default.

The FHA is only part of the problem. The U.S. government must also resolve the roles of Fannie and Freddie, which are returning to health. We’ve previously suggested that the government wind down the companies by slowly selling off their mortgages and securities and honoring the debt they’ve sold to investors. They should be replaced by an independent agency that provides insurance on qualified mortgage-backed securities issued by private entities.

Regulators would also do well to move ahead with new mortgage rules, including standards for non-abusive lending and a requirement that banks assume a portion of risky mortgages on their books. Such rules will give lenders the regulatory certainty they need to re-enter the mortgage market.

The government still has a crucial role to play in the housing market, providing countercyclical support when the market falters. That role will be more secure if Congress tackles much-needed housing finance reform and strengthens the mortgage market for the future.