Sustainable Housing for FHA Borrowers

photo by Michael Daddino

Federal Reserve Bank of New York

Donghoon Lee and Joseph Tracy of the NY Fed have posted a staff report, Long-Term Outcomes of FHA First-Time Homebuyers. It opens,

The Commissioner of the Federal Housing Administration (FHA), David Stevens, in remarks delivered on December 12, 2009, defined the purpose of the FHA as follows. “As a mission-driven organization, FHA’s goal is to provide sustainable homeownership options for qualified borrowers.” These remarks followed a remarkable increase in the scope of the FHA mortgage insurance program in response to the financial crisis and housing bust. This comment by Commissioner Stevens is important in that it clarifies a goal of the FHA program. However, this clarity was not followed up by the FHA with a definition of “sustainable homeownership.” Nor was there any documented attempt by the FHA to develop metrics to track their progress toward this objective, or a commitment by the FHA to make this information available to the public in the future.

Program evaluation is an integral part of any effective program—government or private. We illustrate in this paper that advances in data availability offer the opportunity for the FHA to both define what it means by sustainable homeownership and to measure its progress against this definition. We believe that it would be beneficial for the FHA to be transparent in this effort and to report on not only its definition and metrics, but also on its progress on an annual basis. Improved tracking of long-term outcomes of FHA borrowers will better help inform the FHA on program design. This should lead to improved outcomes over time and enhanced public support.

We focus our analysis on first-time homebuyers who are an important market segment for the FHA. The mission of sustainable homeownership is particularly relevant for these new homeowners. The benefits of a government mortgage insurance program that helps to facilitate the transition from renting to owning rests importantly on the success of these new borrowers in remaining homeowners in the future. However, to date, the FHA has not systematically tracked the progress of its first-time homebuyers after they pay off their credit risk to the FHA. We use the New York Fed’s Consumer Credit Panel (CCP) data to do this analysis starting with the 2002 cohort of FHA first-time homebuyers. (1, footnotes omitted)

This is inarguably right. The FHA should set forth performance metrics and provide annual progress reports for them. For too long, the FHA has cherry-picked metrics without providing a holistic perspective on its performance. The authors conclude,

A stated mission of the FHA mortgage insurance program is to support sustainable homeownership. An examination of the history of the FHA program illustrates a strong initial focus on sustainability, but legislated changes in the 1950s and early 1960s shifted the focus to affordability. If sustainability remains an important goal for the FHA, then it would be desirable for the FHA to define what they mean by sustainability and to track their performance over time. Only by being transparent and holding themselves accountable can the FHA improve on this objective over time. (14)

Amen to that.

Loose Credit. Plummeting Prices.

"Durdach Bros Miller Lite pic4" by MobiusDaXter

Christopher Palmer has posted Why Did So Many Subprime Borrowers Default During the Crisis: Loose Credit or Plummeting Prices? to SSRN. While this is a technical paper, it is clear from the title that it addresses an important question. If it can help us get to the root causes of the foreclosure crisis, it is worth considering. The abstract reads,

The surge in subprime mortgage defaults during the Great Recession triggered trillions of dollars of losses in the financial sector and accounted for more than 50% of foreclosures at the height of the crisis. In particular, subprime mortgages originated in 2006-2007 were three times more likely to default within three years than mortgages originated in 2003-2004.

In the ensuing years of debate, many have argued that this pattern across cohorts represents a deterioration in lending standards over time. I confirm this important channel empirically and quantify the relative importance of an alternative hypothesis: later cohorts defaulted at higher rates in large part because house price declines left them more likely to have negative equity.

Using comprehensive loan-level data that includes much of the recovery period, I find that changing borrower and loan characteristics can explain up to 40% of the difference in cohort default rates, with the remaining heterogeneity across cohorts caused by local house-price declines. To account for the endogeneity of prices — especially that price declines themselves could have been caused by subprime lending — I instrument for house price changes with long-run regional variation in house-price cyclicality.

Control-function results confirm that price declines unrelated to the credit expansion causally explain the majority of the disparity in cohort performance. Counterfactual simulations show that if 2006 borrowers had faced the price paths that the average 2003 borrower did, their annual default rate would have dropped from 12% to 5.6%.

Ok, ok — this is hyper-technical! The implications, however, are important: “These results imply that a) tighter subprime lending standards would have muted the increase in defaults, but b) even the relatively “responsible” subprime mortgages of 2003–2004 were sensitive to significant property value declines.” (40) It concludes that, “In reality, cohort outcomes are driven by both vintage effects (i.e. characteristics bottled into the contracts at origination) and path dependency in that exposure to economic conditions affect cohorts differently depending on their history.” (40)

So, the bottom line is that loose credit and plummeting prices were both causes of the defaults during the crisis. Mortgage underwriters and policymakers are on notice that they need to account for both of them in order to be prepared for the next crisis. This paper’s contribution is that it has quantified the relative impact of each of those causes.