Recommendations and Actions
From the 1930s through the 1970s, the federal government was a major force in stimulating the production of single- and multi-family housing through a variety of means. These include direct financing, loan guarantees, interest rate subsidies, mortgage insurance, development of secondary markets, and tenant subsidies and favorable tax treatment. However, over the last 12 years, the federal role in housing production has been reduced, leaving a number of specific housing needs unmet.
For example, many renters find affordable housing difficult to come by and must devote a high proportion of their income to housing costs. Private sector, multi-family housing production in the last decade was concentrated at the high end of the market. Although that market has softened, rents in newer projects remain out of reach of most renters. Thus, while multi-family vacancy rates are high in some areas and in some markets, affordable rental housing remains very scarce, especially in gateway cities with large low- and moderate- income populations.
Similarly, in the last 12 years, home ownership rates for younger households (age 25 to 39) declined sharply. While lower interest rates increase affordability, down payment and closing cost accumulation remains difficult with income growth lagging and rents high as a proportion of income.
Notwithstanding these needs, HUD has retreated from a significant role in housing production over the past 12 years. On the multi- family side, a HUD privatization initiative of the early 1980s-- coinsurance--left the agency with billions of dollars in losses and made it wary of multi-family production programs. Coinsurance was designed to speed processing of multi-family mortgage insurance applications. Under coinsurance, the private lender was delegated most of HUD's underwriting functions in exchange for assuming a portion of the insurance risk. However, the program did not give the lender adequate incentives to minimize risk; instead, the program encouraged lenders to use inflated appraisals and underwrite more projects to generate fees. By the time HUD shut down the program in 1990, the department estimated that its losses would be in the billions of dollars. Other multi-family insurance programs remained on the books, but, whether by design or mismanagement, processing of insurance applications slowed to a trickle.
In the current budgetary environment, FHA will never have the resources it needs to underwrite significant amounts of insurance and oversee its portfolio of insurance-in-force on a loan-by-loan basis. It will have to rely on third-party delivery systems to be effective. In fact, such partnerships may provide opportunities for innovation. However, as HUD learned from the coinsurance debacle, third-party delivery systems must be carefully designed so that the agency can effectively monitor the program and its partners have an incentive to minimize the government's risk.
Congress had these concerns in mind when it enacted Section 542 of the Housing and Community Development Act of 1992, which authorized HUD to conduct risk-sharing demonstrations with state and local housing finance agencies and government-sponsored enterprises (GSEs) Fannie Mae, Freddie Mac, and the Federal Home Loan Bank. These entities offer safer partners with which to experiment because-- unlike private lenders--as governmental or quasi-governmental entities, they are unlikely to disappear, leaving HUD liable. These demonstrations must be a high priority for HUD to help it define a new role for itself in multi-family housing production.
HUD also has failed to encourage the movement of capital into multi- family production. In fact, very limited funds are available from investors for multi-family housing. In the single-family area, HUD has encouraged standardization of mortgage products and borne the risk while gaining experience from which the private sector could learn to underwrite similar risks. Thus, an efficient secondary market in single-family mortgages and mortgage-backed securities has been developed, but no comparable market in multi-family mortgages exists yet.
On the single-family production side, recent legislative and policy decisions may have had the effect of reducing FHA's share of single- family loan origination. The Mutual Mortgage Insurance (MMI) fund is the self-sustaining mutual fund that provides basic FHA single-family mortgage insurance. In 1990, actuarial studies suggested that the business written each year during the early 1980s was unsound and was rapidly depleting the surplus that the fund had built up during the 1970s.
In response, the Cranston-Gonzalez National Affordable Housing Act of 1990 legislated a number of reforms, including a risk-based premium structure and increased down payment requirements. These changes reduced the affordability of FHA insurance to those most in need of credit enhancement and, at the same time, made FHA insurance less competitive with private mortgage insurance, driving stronger borrowers and those refinancing to other products. This may have contributed to a significant drop in FHA's market share from 13 percent in 1990 to 5.6 percent in 1992 (based on the dollar volume of business including refinancing).
As HUD reduced its role in housing production, state and local governments and the nonprofit sector have tried to fill the gap, creating innovative programs to develop housing and revitalize neighborhoods. While there may never again be federal funds on a massive scale, federal investment can be the catalyst for significant change when various forces are targeted at one area. Such a coordinated effort should be driven by the initiative and creativity of local partners familiar with local conditions. The FHA has not played this catalyst role effectively in the past, but it has the capacity to provide housing credit, a key component in economic revitalization of declining neighborhoods.
There is, therefore, an important role for HUD to play in housing production; however, HUD does not have all the tools it needs to play that role. Getting back in business in today's rapidly changing and complex marketplace will require yet greater financial and management sophistication. The reliance on third-party delivery systems implicit in each of these production initiatives only increases the importance of having sophisticated tools to manage risk. The FHA is one of the nation's largest financial institutions and its activities affect crucial segments of our economy, yet it lacks the financial and management systems and skills of its private sector counterparts. The HUD Inspector General has warned repeatedly that FHA lacks automated systems and internal controls sufficient to oversee its financial assets. Federal regulators would never permit a private sector financial institution to operate as the FHA has operated. Federal resource constraints have prevented the Federal Housing Commissioner from making all of the investments in automation, systems, and skills that could produce significant savings.
1. HUD should stimulate multi-family housing development through risk-sharing with housing finance agencies.
FHA should implement the risk-sharing demonstrations with housing finance agencies and GSEs authorized by Congress last year and use these programs as models for developing other third-party delivery systems with sufficient controls and incentives to protect the government's interests.
2. HUD should stimulate multi-family housing production by helping to develop a secondary market for loans on multi-family properties.
FHA, working with the GSEs and the private capital markets, should develop further the secondary market in multi-family mortgages and mortgage-backed securities. This effort will require providing the private sector with more information so that it can analyze products, working with the GSEs and the private sector to determine where FHA credit enhancement will have the greatest impact in expanding access to credit, and working to standardize investment terms and documentation. FHA might also consider moving from insuring individual loans to insuring pools of risk. FHA will need to use the expertise of the private sector in building the tools and models to underwrite this type of risk.
3. Legislation should be enacted to authorize FHA to improve access to capital and assist moderate-income, first-time home buyers in high-cost areas.
Police, fire-fighters, teachers, and other moderate-income workers would benefit from legislation increasing the FHA insurance loan limits. In addition, Congress should authorize a single-family risk- sharing initiative like the multi-family risk-sharing demonstrations authorized last year. On the single-family side, FHA and state and local governments could help moderate-income buyers in high-cost areas by sharing the insurance risk on loans up to the conforming loan limit set by the Federal National Mortgage Association (FNMA) and the Federal Home Loan Mortgage Association (FHLMC) (about $203,000). For example, FHA could insure a loan of up to the FHA loan limit and the state or local agency would insure the remainder of the loan amount.
4. Legislation should be enacted to authorize FHA to work in partnership with local governments and nonprofits striving to revitalize decaying neighborhoods by making special terms available for FHA-insured mortgages in those areas.
Specifically, FHA should make a no-down-payment option available for loans targeted to first-time home buyers with incomes below 115 percent of median family income. This should be available in communities where coordinated affordable housing programs are being carried out, state or local agencies are targeting programs, nonprofit and community development corporations are making investments, or private lenders are doing community reinvestment activities. Under such a program, the insured loan amount could equal 100 percent of the value of the property; closing costs could be provided through other government, nonprofit, or seller contributions; and front-end mortgage insurance premiums could be deferred until sale.
Certain controls would be necessary to protect the government's interest while the impact of the program is assessed. For instance, the total number of loans insured under the program should be limited; prepurchase counseling should be required; and the mortgage amount should be capped at the lesser of $75,000 (or 75 percent of the FHA mortgage limit if that is greater) or 100 percent of the property value. Such a program would permit FHA to develop experience working with various kinds of partners in revitalization areas. This will help the FHA to determine how federal credit enhancement can best be leveraged with other local programs to help turn around decaying neighborhoods and help those with the greatest need.
5. HUD should make cost-effective investments in professional financial management.
HUD should be given the resources to make cost-effective investments to improve FHA's automated systems and internal controls, develop the financial and technical skills of FHA employees and attract private sector expertise, and take advantage of new workplace technologies.
Housing Finance Agency (HFA) multi-family risk-sharing will reduce the labor-intensive underwriting and project monitoring demands on FHA staff and is a cost-effective way of dealing with severe resource shortages. Effectively, HUD staff resources used to focus on program development and control will be leveraged with the capacity of the HFAs, and the result will be a greater capacity to stimulate production. At the same time, by building solid relationships with state and local HFAs--laboratories for innovative financing--risk- sharing could be the first step to developing other creative partnerships targeted to meet the needs of individual states or communities.
Development of a secondary market in multi-family mortgages that will bring more capital into multi-family lending is critical to the future of rental housing production. Developing an actuarially sound insurance product for risk pools would be an important step in the evolution of FHA from a retailer to a wholesaler and would represent a more efficient use of government resources. At the same time, by working with the private sector to develop the necessary models and expertise and share databases, FHA would develop relationships with new parts of the industry that could produce other innovative ideas to meet market needs.
Raising the single-family loan limits would provide the benefits of FHA-insured mortgages to a wider income-range of first-time home buyers and to those in areas with high housing costs who are struggling to make home ownership affordable. The no-down-payment program can serve as a laboratory in which FHA develops relationships and learns how successful local revitalization partnerships can work. At the same time, the credit opportunities that the FHA could bring to declining neighborhoods could leverage additional investments and be the catalyst for coordinated revitalization efforts.
Cost-effective investments in expertise, systems, and technology are necessary to transform FHA into a modern financial institution with a social purpose and the business tools to get the job done.
A multi-family risk-sharing demonstration program could be administered within the current budget for the FHA credit subsidy programs. Expansion of the program could require additional resources to be determined after there is some experience with the program.
Development of a secondary market in multi-family mortgages could assist in HUD's sale of some of its own multi-family note inventory to the financial markets. Developing these innovative products would take staff resources, but over time these efforts would reduce HUD note-servicing workloads, freeing staff to more effectively monitor its loan portfolio and prevent loss.
The MMI fund (single-family loans) is actuarially sound. Increasing the loan limits may have a positive impact on the fund's balance sheet. The no-down-payment program may or may not entail additional credit subsidy requirements in the future, but whether there will be a need and its extent if any can only be ascertained after some experience with the program.
Investments in systems, technology, and skills are the sort of steps that private sector organizations make to improve the productivity of their operations and ultimately will produce a more cost-effective product. These steps would require additional appropriations in the short-term.
Since its creation during the Depression, the FHA has served not only to strengthen the nation's housing stock, but also to spur employment in the crucial construction sector. Thus, each of the production initiatives has the additional benefit of stimulating economic growth, which would produce tax revenues. These fiscal gains cannot be accurately predicted.
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