The Housing Market Does Not Need Stimulus from the FHA

At the height of the housing bubble in 2005, both existing and new home sales reached all-time highs—7 million for existing home sales for the year and nearly 1.4 million for new home sales. To put the housing bubble in perspective, new home sales increased three-fold from their low in 1991 to their high in 2005. Home prices as measured by the Standard & Poor’s Case-Shiller Home Price Index rose more that 200 percent between the mid-1990s and the height of the housing bubble.

The housing bubble was caused by people buying homes they could not afford, banks making risky loans, and government policy that encouraged irresponsible borrowing and lending. Many Americans struggled to pay their mortgage. Mortgage debt-service payments as a share of disposable income reached a record high of 7.2 percent in December 2007, the start of the Great Recession.

Banks made mortgage loans to risky borrowers. From the early 2000s to 2007, the share of mortgage originations to consumers with the lowest credit scores more than doubled from 7 percent to 15 percent. Banks were willing to make risky loans because they could simply sell the loans to Fannie Mae and Freddie Mac.

After enduring the collapse of the housing bubble, the government should evaluate carefully any policy that encourages excessive mortgage debt. Days before leaving office, President Barack Obama ordered the Federal Housing Administration to cut its mortgage premium for 2017 by a quarter point to 0.6 percent. This premium cut was intended to expand opportunities for home ownership; the FHA makes mortgage loans to consumers with a below-average credit score and it requires a smaller down payment than conventional mortgages would.

After President Donald Trump’s inauguration, the new administration reversed Obama’s action. Based on the results of an earlier mortgage premium cut in 2015, President Trump was right to reverse course. The 2015 cut did little to save borrowers money or expand home ownership. The main reason it did not work was that housing demand was already strong. When the housing market is strong, an FHA premium cut does little to incentivize new buyers. Most of the new FHA borrowers in 2015 would have entered the market regardless of whether there was a premium cut. Instead of saving, some of those borrowers spent the premium cut on larger homes with more amenities.

The housing market has substantially recovered. Both existing and new home sales fell to all-time lows between 2010 and 2012. But at the beginning of 2017, existing home sales are on track to reach 5.7 million this year from their low of 3.4 million in 2010. New home sales are on pace to reach 570,000 this year from a low of 270,000 in 2011. Nationwide, home prices have risen 37 percent since the bottom of the housing market. They have risen even faster in major cities. The S & P Case-Shiller major-city price index, which includes places like New York City, Denver, and Los Angeles, is up 41 percent since 2012.

The housing market has been helped by a steadily improving labor market. The U.S. economy continues to crank out jobs, adding 2.1 million new positions over the past 12 months. The unemployment rate has fallen to near post-recession lows. A broad measure of unemployment that includes part-time workers is also hovering at post-recession lows. There finally appears to be some life in wage growth: Average hourly earnings have increased 2.5 percent over the past year. And household wealth has reached record high levels, helped by gains in the stock market. This adds up to more consumers seeking to buy a home rather than rent.

Home mortgage financing and affordability have also helped the housing market. The interest rate on a conventional 30-year, fixed-rate mortgage is at its lowest level in decades. Mortgage rates peaked in the 1980s at 13.7 percent. During the housing bubble they were around 6.25 percent. Today, rates are closer to 4 percent. Lower interest rates have made mortgages more affordable. During the height of the housing bubble in 2005, the National Association of Realtors Mortgage Affordability Index averaged 112. Today the affordability index stands at 161. (A higher index value means mortgages are more affordable.) Mortgage debt-service payments as a share of disposable income have fallen to 4.5 percent from a high of 7.2 percent.

Supply has not kept pace with the strong demand for homes. During the housing bubble, home completions reached a high of 2.2 million. Home construction collapsed after the housing bubble burst. In 2011, home completions fell to an all-time low of 500,000. Since 2011, they have rebounded but remain low by historical standards. At the beginning of 2017, home completions stood at 1 million, which is near the lows seen in previous cycles. The combination of strong demand and slow construction means supply is tight.

Today, housing is a seller’s market. At the current pace of sales, the supply of homes available will be exhausted in less than four months. In comparison, when the housing market was at rock bottom, it would have taken 12 months to exhaust the supply of homes for sale. The National Association of Realtors defines a seller’s market as having less than six months of supply. By this definition, housing has been a seller’s market since 2012. During a seller’s market, when demand is strong and supply is tight, an FHA premium cut does little to expand home ownership.

The goals of the FHA premium cut in 2015 were to incentivize 250,000 new buyers with FHA mortgages and to save borrowers an average of $900 each year. Analysis suggests that the results fell short on both counts.

Recent analysis shows that of the 217,000 new FHA loans in 2015, 180,000 were to first-time buyers. Of those, only 34,000 entered the market because of the premium cut. A group that we are calling trend consumers, or 58,000 buyers, would have pursued an FHA mortgage anyway because of an improved labor market. Another portion, or 86,000 of the new FHA mortgagees, can be attributed to poaching. Poaching refers to consumers taking on FHA loans instead of loans from other agencies serving low-income buyers, such as Fannie Mae and Freddie Mac.

Did the FHA premium cut in 2015 save borrowers money? The cut gave borrowers about 6 percent more buying power. However, that was partially offset by higher home prices. In 2015, prices for FHA-financed homes increased 3 percent more than prices for homes with conventional mortgages. The 3 percent increase occurred for two reasons. Greater demand from FHA borrowers drove up prices by 1 percent. The other 2 percent increase in the price of FHA-financed homes came from buyers moving up in the market, purchasing larger homes with more amenities.

The FHA premium was designed to compensate the FHA for additional risk; it was not meant to be adjusted to incentivize home ownership. FHA borrowers compensate for their lower down payments and lower loan rates by paying a mortgage premium. The premium is paid into the Mutual Mortgage Insurance Fund, which is used to settle any FHA defaults.

The collapse of the housing bubble resulted in widespread defaults on conventional and FHA mortgages. Because of the defaults, the FHA Mutual Mortgage Insurance Fund required a taxpayer bailout in 2013. Since 2013 the capital position of the fund has improved: Over the past four years, the fund’s capital has increased by $43.9 billion, for a capital ratio of 2.3 percent, just above the statutory 2 percent capital requirement. Lowering the premium would reduce the fund’s ability to handle defaults in an economic downturn.

Based on the results of the FHA premium cut in 2015, another premium cut would do little to expand home ownership or save homebuyers money. It would also likely push home prices higher. A premium cut would also hurt the insurance fund, which has been carefully rebuilt after a bailout. It’s a seller’s market. Demand is strong and supply is tight. It is not demand that needs a boost, it is supply.