Reason Foundation

FHA's Troubles Are No Myth, Despite What HUD Tries to Spin Away

Posted on March 30, 2012, 3:42pm | Anthony Randazzo

When we have a gala later this year for the Annual Unintended Consequences Awards, the Department of Housing and Urban Development is sure to be a leading nominee in the "Overall Body of Work for a Federal Department" category. Though I will give HUD a nod for at least recognizing the rising voices of opposition to its frequent missteps as they have developed a pattern of releasing "Myth vs. Fact" documents. Their myth memo for the mortgage settlement was a real strong effort towards securing the AUC Award, and now they have followed on with a recent release for comments on the Federal Housing Administration's struggles.

Former Fannie Mae chief credit officer Ed Pinto went through their 19-point "Myths and Facts Regarding the FHA Single Family Loan Guarantee Portfolio" document and pulled out a few of the most egregious comments. Here are some of his notes. (And bear in mind his four principles for FHA reform: 1) Utilize generally accepted accounting principles, and set rigorous disclosure standards; 2) Establish and maintain loan loss and unearned premium reserves; 3) Establish and maintain a minimum capital requirement of 4 percent of amortized risk in force; 4) Fund a countercyclical premium reserve.)

HUD Lables As Myth: FHA would be declared insolvent by state regulators were it a private mortgage insurance (MI) company.

HUD’s response does not deny the truthfulness of this statement.  Instead HUD points out FHA’s counter-cyclical role.  Yet during the boom HUD used FHA and other agencies and policies to lead a self-described “revolution in affordable housing”. The central policy of this revolution was the near elimination of downpayments, a pro-cyclical policy in the extreme.   HUD seems to espouse a policy of being pro-cyclical in booms and counter-cyclical in busts.

Elsewhere HUD points out that the FHA’s access to funding from the Treasury Department makes complying with private sector standards unnecessary.  This may be comforting to HUD, but the Congress and taxpayers deserve more than HUD’s assurances that all will be well. The FHA is the third largest financial guarantee entity in the United States, surpassed only by Fannie Mae and Freddie Mac (the GSEs). Yet it continues to operate under fiscal standards that can only be described as Byzantine.

 Consider the experience with the GSEs. In July 2008 the GSEs were given a clean bill of health by its regulator, the Office of Federal Housing Enterprise Oversight (OFHEO, now FHFA).  In a statement, OFHEO Director James B. Lockhart opined: "OFHEO has been monitoring and continues to monitor closely Fannie Mae, Freddie Mac, and the mortgage and financial markets. As one would expect, we are carefully watching the Enterprises’ credit and capital positions.  As I have said before, they are adequately capitalized, holding capital well in excess of the OFHEO-directed requirement, which exceeds the statutory minimums.  They have large liquidity portfolios, access to the debt market and over $1.5 trillion in unpledged assets."

During the month of August 2008, the Department of Treasury hired Morgan Stanley to undertake an independent review of the GSEs. 

The taxpayers know all too sadly the outcome of this review—the very next month the GSEs were placed in conservatorship by FHFA with the bailout bill now approaching $200 billion.  

The questions relating to FHA’s current safety and soundness are substantive.  A review similar to the one undertaken with respect to the GSEs in 2008 is undoubtedly needed.  Under private accounting principles FHA likely has a current net worth of -$13.5 billion and an overall capital shortfall under its mandated 2 percent standard of over $32 billion.  This is clear evidence that FHA’s current capital is woefully inadequate today.   

There is hope that this critical review will take place.  On March 27, 2012 the Financial Services Committee of the U.S. House of Representatives without objection from a single Republican or Democrat agreed to H.R. 4264: “The FHA Emergency Fiscal Solvency Act of 2012.”     

Section 15 mandates that the Comptroller General of the United States provide for an independent third-party one-time safety and soundness review of the FHA “in accordance with generally accepted accounting principles applicable to the private sector.”

HUD Lables As Myth: FHA should hold capital levels like a private MI.

HUD bases its entire response on the erroneous statement that private MIs must “isolate their older’ weaker books of business from any recent and healthier year-by-year activity.”  This is not true.  Like the FHA, each MI consolidates all its annual books of business in computing a single capital position. Further, the private MI industry has raised or received over $10 billion in new capital since September 2007, none of which was segregated by book year.

FHA should not be allowed to operate is an unsafe and unsound condition, while it unfairly competes with a private sector that has invested and continues to invest real capital. As is noted below, FHA and other government guarantee agencies should credibly begin stepping back from markets that can be served by the private sector and return to a traditional 10 percent home purchase market share.  If this were done, more not less capital would enter the market.

HUD Lables As Myth:FHA masks expected losses by using overly optimistic assumptions regarding future home prices.

HUD appears to agree with this “myth,” but uses the excuse that the projections used in the November 2011 Actuarial Study date from July 2011.  No publicly traded company would be allowed to hide behind such an excuse. Again there is hope that HUD’s disclosures will be held to a similar standard as applies to the private sector.  Section 16 of the above referenced H.R. 4264 also sets disclosure standards for HUD with respect to FHA:

1. Disclosures must provide meaningful financial information and other information that is timely, comprehensive, and accurate;
2. Disclosures must not contain any material misstatements or misrepresentations;
3. Disclosures must make available all relevant information; and
4. Disclosure must not have material omissions that make the contents misleading.

The Congress and taxpayers deserve nothing less than timely, comprehensive and accurate disclosures from a trillion dollar financial entity. While HUD is to be commended for taking steps to increase premiums, eliminate incompetent lenders, and tighten some underwriting standards, it has done little to:

- Address the urgent need to move forward with housing finance privatization; and
- Credibly undertake a return to FHA’s core mission to provide sustainable lending to low- and moderate-income and minority borrowers. Today 90 percent of all mortgages are guaranteed by the Government Mortgage Complex (GMC), consisting of Fannie, Freddie, Ginnie/FHA. Ginnie/USDA, and Ginnie/VA.  Clear and credible steps must be taken to step back from the GMC’s market domination.  Yet even as FHA takes steps to reduce its share, much of the slack is merely taken up by Ginnie/USDA and Ginnie/VA.  

Follow Ed's regular FHA missives here.

Minimum Wage Kills the $5 Footlong in Frisco

Posted on March 29, 2012, 11:37am | Anthony Randazzo

As a rule, I hate the Subway $5 Footlong commercials. I give all due deference to the ad agency that came up with the promotion. From a business perspective it is brilliant advertising. Though the "catchy" nature of the tune is why I (and I'd imagine many others) despise them. Also, I am constantly frustrated at the workers in the Subway near our Reason office in DC for being so stingy with the black olives. (Who eats just four black olive slices?)

Nevertheless, annoyingly memorable commercials aside, that is no reason to attack and get rid of the $5 Footlong—which is effectively what San Francisco has done by raising the minimum wage to $10.24 this year. Here is the story from a local Bay Area NBC affiliate:  

The sandwich-making chain stopped selling the five-dollar footlongs in San Francisco due to the "high cost of doing business," according to SF Weekly. Signs posted at Subway sandwich shops sadly inform San Francisco patrons -- we hear Willie Brown is a big fan -- that "all SUBWAY Restaurants in SF County DO NOT PARTICIPATE IN Subway National $5.00 Promotions," according to the newspaper. [...]

Apparently, the city's new minimum wage, raised to $10.24 as of Jan. 1, make $5 footlongs an impossible business model.

This is not really surprising. The economics on the unintended consequences of the minimum wage have long been established. It is almost self evident: just ask why we should not raise the minimum wage to $500 or $1,000 a hour and you get the same answer as to how $10.24 per hour can be unsustainable.

Proponents of minimum wage laws suggest that businesses should just eat the extra cost, since those rich fat cat owners of capital and industry can afford it, so that the lower class folks can earn a "livable" wage (a term highly open to interpretation). But as Subway is apparently demonstrating, at a certain point you can't run at a loss. And so the costs are getting passed on to the customers of Subway in San Francisco. 

More from Reason on the minimum wage here.

Bernanke Resolved to Favor Traders, Inflation, and Government Debt with Continued ZIRP

Posted on March 27, 2012, 1:59pm | Anthony Randazzo

Fed Chairman Bernanke told the National Association for Business Economics conference this week that the labor market was still in “deep” trouble and so we should expect ZIRP (zero interest rate policy) to continue for the next several years.

His comments stand in sharp contrast with the hyper-campaign-mode-minded Obama administration, which insists its policies since taking over are the reason why employment is improving. Ignore the data in these charts hidden behind the curtain though: White House unemployment projection and unemployment rate including labor market non-participants and dissatisfied part-time workers. 

Putting the politics aside, what Bernanke is essentially saying is that he prefers the trade off of propping up stock prices versus encouraging savings. 

He prefers low rates that enable federal borrowing to be more manageable in excess versus allowing housing prices to fall to their natural bottom and homeowner debt deleveraging to pick up steam. 

Just like his comments on the gold standard last week, he has it all backwards. The Wall Street Journal notes:

Mr. Bernanke argued, seemed likely to require "more-rapid expansion of production and demand from consumers and businesses, a process that can be supported by continued accommodative policies,"

The idea is that if consumers can borrow at low rates they can consume more. But since savings rates are next to nothing, ZIRP actually is dragging the consumer’s preferred preference of develeraging. So we don’t see housing hold debt declining very far nor is consumption carrying the economy forward.

The idea is that if businesses can borrow at low rates they will invest in their operations, hiring new workers with the cheaper cost of money. But since fiscal policy is threatening substantial regulatory and tax changes, and ZIRP itself creates inflation concerns, most new business activity gets sidelined in the uncertainty.

The idea is that with ZIRP, we can get positive inflation pressures that help stave off deflation. But deflation is often a good thing. Would you rather the price of iPhones go up or down? 

Finally, even if low-interest rates were the answer to jump starting the economy, they ignore that labor market problems go much deeper than the 2008-09 recession or the financial crisis. We have structural changes in the types of labor demanded in the U.S. that our workers are not well trained to accomplish. This is something that can’t be fixed over night nor can it be addressed by a simple economic growth upswing. 

From the WSJ:

How Rising Health Costs Will Hurt the Economy

Posted on March 27, 2012, 11:48am | Anthony Randazzo

Beyond just government spending on health care increasing in the coming decades, which is a rather hot topic this week, private health care costs are set to grow at an increasingly exponential rate in the coming years. This is not necessarily something new, as we've had rising health care costs for decades now. But what is going to be a challenge for the economy is that economic prosperity trends America had in the 20^th century were able to absorb these rising costs in a way we won't see in the next few years since those trends have flatlined.

Rising health costs are not new...

America has gone from spending $147 per capita on health care in 1960 to around $8,400 per capita in 2010 on health care. And as life expectancy has increased from 69 years to 78 years during that timeframe, the costs have picked up more rapidly. And that is not to mention that technological advances while more life saving have also been more costly.

But economic trendlines are flatlining...

Prior to 1960 we had a significant period of economic prosperity. Entrepreneurship and innovation and labor force expansion and education were all on the upswing in the early to mid part of the 20^th century. As a result, we were able to absorb inflating health care costs without it too dramatically hitting economic growth. However, all of those factors have flatlined at various points in the past few decades. And the trends are catching up to us. As a result, the increased costs over the next decade are going to have much more visible effects than in the past. Here are three examples:

1—Labor Market Participation: According to the most recent BLS data, there are actually more people outside the labor force today than there were a year ago when the unemployment rate was higher. If we were to add those who have stopped looking for a job in the past month to the labor data, the headline unemployment rate would go from 8.3% to about 9.6%, according to CBO projections. Unfortunately, this weak labor market participation is a long-term trend. The labor force stopped growing substantially in 1990, and today's labor force participation rate has actually declined to levels last seen in the early 1980s.

This is important because much of America's economic growth following World War II came with a substantial surge in labor market participation, particularly by women entering into the work force, going from 32.7% of the work force in 1948 to 58.1% in 2011. The baby boomer generation also helped fuel the economic boom. Larger labor pools enabled capital to be put to work more efficiently. Even if economic output continues to grow with all these workers on the sidelines, our output is dramatically lower than where it would be if we had more people working. A two-decade flatline in labor market participation that is declining means bad news for output in the coming years.

2—Education Results: At the same time that the labor force was expanding in the 20^th century, education gains were rapidly moving forward. From 1900 to 1970, high school graduation rates climbed from 6% of children to 80% of children. But since then we have flatlined, and even declined a bit in graduation rates. The number of high school grads relative to the population has fallen to 9.6%. Even with life expectancy and the baby boomers adding age to the overall population-this is a sign of substantial stagnation. Test scores in core subjects have also flatlined since the 1970s, according to a 2011 report from the National Center for Education Statistics. This may not appear to be a problem, but given the technological advances and teaching method advances since the 1970s, we should expect test scores to increase.

These and other flatlining education trends mean less competitive American workers, slower adaptation to shifts in economic fundamentals, and exacerbated employment problems. Low-skill labor opportunities are shrinking every day due to automation, efficiency gains, and the capacity to outsource some manufacturing work. Workers of the future will have to be even better educated then the current generation to compete in a world of skilled labor.

3—Innovation and Entrepreneurship: The lifeblood of the American economic miracle has always been new businesses. But since peaking in 2006, employment in new businesses and registration of new businesses has seen substantial declines. Entrepreneurship was down nearly 25 percent in 2011 compared to 2006. And economist Tyler Cowen has laid out a strong case that innovation has been one the decline in America since the 1970s. This means that innovation and entrepreneurship have had correlated slow downs with the labor market expansion's stall out and the drop off in educational advances.

This means weak economic prospects in the near- to medium-term...

All of this suggests we should not be expecting the big GDP growth period often seen after recessions. We have had a recession, a financial crisis, a global fiscal crisis, a national debt crisis all hit at the same time that innovation, entrepreneurship, education, and labor trends have taken negative turns. And this is not to mention that America's major growth sectors are changing and it is going to take time to reorient the work force to the new growth sectors.

What kind impact will these trendline shifts cause?

To start with, having more GDP resources taken up by health care spending means less business investment, translating into fewer jobs.

• Based on current policies, the CBO has recently projected that mandatory government healthcare spending will rise from 10.4% of GDP in 2012 to 12.8% of GDP in 2020. 
• Private health care costs are also expected to rise at an increasing rate over the remaining years of the decade as the Centers for Medicare and Medicaid Services projected last summer average annual health spending to outpace growth in the overall economy and reach $4.6 trillion in national health spending by 2020, or 19.8 percent of GDP. 

The more that health care costs consume GDP, the less capital the economy will have to build on. That means lower economic growth from business expansion, and possible continued challenges for unemployment over the next decade-don't be looking for that 6% unemployment rate any time soon.

In tandem, those rising health care costs are going to limit innovation and entrepreneurship. As new business start-ups are the lifeblood of the economy, this means lower GDP growth, translating into higher federal budget deficits.

Furthermore, rising health costs also mean the household debt situation will deleverage slower, hurting housing, and by extension economic recovery.

Conclusion

The take away here is that the impact of rising health care costs will be much more acute in 2020 than in 1980-unless of course we see some unexpected innovation that is on the scale of the Internet emerge to power the economy forward. Many of the growth trends we relied on in the path are flatlining and the low-hanging fruit of innovation is disappearing, as Tyler Cowen would say.

The good news is that the nature of todays and the next decades' economic woes are transitional. Our economic sectors are shifting. Our education system is not breaking down so much as struggling to adjust to changes in economic fundamentals. And the America spirit will adapt. The question is when.