Rossi to Congress: Make FHA a Better Risk Manager

SMITH BRAIN TRUST -- Smith School Professor Cliff Rossi on Thursday outlined measures to a congressional subcommittee to make the Federal Housing Administration a better risk manager to rehabilitate its “extremely weak” Mutual Mortgage Insurance Fund. Rossi, who’s held senior risk management positions at Fannie Mae and Freddie Mac, testified about FHA oversight before the U.S. House Committee on Financial Services. Spurring reform talk is an MMIF that, Rossi said, is “maligning the FHA.” He cited its $1.7 billion appropriation in 2013 “after the fund was determined to not have sufficient reserves to pay all expected losses.”

“FHA reform must be undertaken to reduce the role of the federal government in the mortgage market, increase the role of private sector capital and prevent future taxpayer bailouts,” Rossi said. He suggested five solutions.

1. Clarify and align mission and requirements with other market participants. The agency needs to get back to its historical roots of focusing on low- and moderate-income borrowers that comprise 10-15-percent of the market. The FHA should phase out area-based loan limits and adopt an area median income target to determine program eligibility. For example, the Federal Home Loan Banks’ Affordable Housing Program provides subsidies to borrowers with median incomes at or below 80 percent of area median income.  The agency also should raise the bar on collateral, credit, and capacity criteria to repay the mortgage to help ensure more borrowers stay in their homes.

2. Allow FHA to engage in risk-sharing arrangements. With no mechanism to transfer credit risk, the agency winds up holding 100 percent of the credit risk. GSEs, like Fannie and Freddie, for example are allowed to share risk with private insurers. Such mortgage insurers provide first-loss coverage between 25-35 percent.

3. Reduce 100-percent coverage. Such a move would incentivize borrowers to avoid foreclosure. The reduction would further move investors to require servicers to exhaust all viable loss mitigation options to keep the borrower in their home before resorting to foreclosure, and even conduct more prudent underwriting when originating a loan.

4. Better-align with conventional mortgage “Ability to Repay” rules. The Dodd-Frank Wall Street Reform and Consumer Protection Act yielded “Ability to Repay” rules for conventional mortgages, including a 43-percent debt-to-income requirement. The FHA published a similar standard – except that it allows for lender-discretion for borrowers to exceed the ratio. Lenders exercise such discretion  based on statistical models that were oftentimes overused before and during the subprime meltdown. FHA loans that exceed the 43 percent debt-to-income standards should be manually underwritten by the agency rather than by lenders.

5. Connect the analytics. The FHA and GSEs are using different numbers to calculate key metrics in their respective risk models. This leads them to different conclusions about how to price future risk and the fees associated with that insurance. The calculations should be the same in order to avoid incongruous pricing policies between the GSEs and FHA.

Learn more about the hearing and link to Rossi’s full testimony here.