Policy Changes Shrink FHA Taxpayer Subsidy in Obama Budget

The Federal Housing Administration spending plan released today by President Barack Obama projects a $943 million taxpayer subsidy for the agency as fee increases and tighter underwriting shrink a $16.3 billion shortfall predicted in November by an independent actuary.

The subsidy would mark the first time the government mortgage insurer has taken aid from the Treasury in its 79-year history. The agency’s estimated losses on defaulted loans, especially those in its reverse-mortgage portfolio, are worse than those in the actuary’s report, FHA Commissioner Carol Galante said. Still, the policy changes will generate about $18 billion this year, almost enough to offset the costs, she said.

“FHA, while still under stress from legacy loans, has made significant progress and is on a sound fiscal path,” Galante said during a conference call with reporters today.

An improvement in the FHA’s finances could affect congressional efforts to rein in its operations. Spurred by concerns that the agency may start adding to the federal deficit, Democrats and Republicans in Congress have been working on legislation to limit the FHA’s housing-market role.

Rising real-estate prices improved the agency’s outlook, Galante said. Still, those gains were more than offset by declining interest rates, which cause drops in the agency’s revenue by inducing customers to refinance out of FHA loans, she said.

The housing recovery did benefit Fannie Mae and Freddie Mac, the mortgage financiers seized by the U.S. in 2008. Obama’s budget predicts for the first time that the government bailout of the two companies will turn a profit of as much as $51 billion by 2023.

Future Losses

FHA is required to keep enough cash on hand to cover all expected future losses. The agency has until Sept. 30, the end of the fiscal year, to make a final determination of whether it will require aid from the Treasury for the first time ever.

The FHA’s shortfall stems largely from loans it backed from 2007 to 2009 when it expanded its book of business as private capital evaporated. Those loans alone are projected to cost the agency $70 billion.

While policy changes have ensured the FHA can cover costs in its traditional mortgage business, its need for a subsidy is now being driven entirely by losses from reverse mortgages, Galante said. The FHA backs 90 percent of such mortgages, which enable homeowners age 62 or older to withdraw equity and repay it only when their homes are sold. Declining home prices have left FHA holding properties worth less than the amount borrowed.

Mitigate Losses

FHA will mitigate losses in the program with new requirements for financial assessments of potential borrowers and mandatory escrow accounts for payment of insurance and taxes on the properties.

The agency insures $1.1 trillion worth of mortgages and backs about 15 percent of the U.S. loan originations for home purchases, almost quadruple the 4 percent share it covered in 2007. About 9.5 percent of loans insured by the FHA are at least 90 days delinquent.

The budget prediction for the FHA is being followed in Congress, where Democrats and Republicans are working on legislation that would further tighten the agency’s underwriting.

Leaders of the Senate Banking Committee have pledged to work on a bipartisan bill to restructure the agency. Republicans in the House of Representatives are working on their own measure.

Under consideration are policies that would reduce the share of the government guarantee on an FHA loan, which now stands at 100 percent, possibly through a risk-sharing arrangement with private guarantors. Lawmakers are also considering policies that would limit the agency’s role to providing insurance to low- or moderate-income borrowers. Currently, borrowers at any income level can qualify for FHA coverage.

Clea Benson in Washington at cbenson20@bloomberg.net;