The billion-dollar question facing Carol Galante

The FHA is on the brink on the next big government bailout. Potentially.

Federal Housing Administration Commissioner Carol Galante is a regular on Capitol Hill these days.

New members on the Senate and House banking committees seek some one-on-one face time with the assistant secretary of housing while long-time members wrangle over how to shore up the FHA’s mutual mortgage insurance fund, whose capital reserve ratio fell into negative territory last year. On April 10, President Barack Obama’s budget predicted a $943-million government bailout for the FHA would be required.

It’s a critical time for the agency. If it takes a subsidy from the Treasury, it will be the first time in the agency’s nearly 80-year history. Just as housing’s fledgling recovery gives cause for hope, the FHA’s floundering finances give pause. A stark partisan divide on Capitol Hill adds a level of uncertainty for the historical agency — both acclaimed and disparaged for its role in the aftermath of the housing crisis.

“They were clearly the ‘Last Man Standing,’ like the Bruce Willis movie,” said Anthony Sanders, a professor of finance at the School of Management at George Mason University, whose research focuses on real estate finance. “Everyone else got knocked out of the box. They are literally the insurer of last resort.”

U.S. Rep. Jeb Hensarling, R-Texas, chairs the House Financial Services Committee where a series of hearings are under way on the FHA’s financial conundrum. The Senate Committee on Banking, Housing and Urban Affairs is holding its own set of hearings.

“If the FHA were a private financial institution, likely somebody would be fired, somebody would be fined and the institution would find itself in receivership,” said Hensarling, as the committee’s round of hearings examining the FHA’s role in housing finance got under way. “Instead, it is merely and merrily on its way to becoming the recipient of the next great taxpayer bailout.”

Later, in the same hearing, Hensarling derisively questioned whether the FHA had morphed into Countrywide Financial — at one time the nation’s largest subprime lender and now blamed for many of the excesses that contributed to the financial crisis.

On the other side of the aisle, the House committee’s ranking Democrat, Rep. Maxine Waters, D-Calif., staunchly defended the agency. She recently reintroduced the FHA Emergency Fiscal Solvency Act, which last year passed the House with bipartisan support but went no further.

“In the aftermath of a housing crisis, precipitated by privately funded and poorly underwritten subprime mortgages, FHA stepped up, providing crucial liquidity and access to the mortgage market,” she proclaimed during the same hearing. The committee has held four hearings so far this year.

On the Senate side, Congressman Bob Corker, R-Tenn., recently grilled Housing and Urban Development Secretary Shaun Donovan as to whether Galante — seated behind Donovan at the time — had enough chops to steer the FHA out of its financial difficulties. He assured Corker she did.

Galante takes all the rhetoric in stride.

“I have definitely been making the rounds with some of the folks on the House and on the Senate (committees),” she said during a recent conversation with HousingWire. “The job can be stressful,” Galante admitted during our conversation. “It’s fast-paced — a lot of balls to juggle — but I’ve said this a lot of times in my career, not just here. I am happiest when I have a lot of balls in the air. That means I’m very happy at the moment.”


To be sure, the FHA wasn’t immune to the stresses of falling home prices and high unemployment during the Great Recession. In 2012, its MMI capital reserve ratio fell to -1.44%, representing a negative economic value of $16.3 billion. The news wasn’t a complete surprise. The fund has been below its statutory 2% requirement since 2008. Still, it wasn’t until the November 2012 independent actuarial report with its negative capital reserve ratio spelled out in black and white that politicians ratcheted up attention on the housing giant.

Housing experts are quick to note the countercyclical role the FHA played during the housing crisis. Without such a role, the foreclosure crisis would have been more severe, they contend.

“Arguably the most important policy response to the housing crash has been the dramatic expansion of FHA lending,” wrote Mark Zandi, chief economist with Moody’s Analytics, in a 2010 unpublished, informational memo for FHA officials that modeled the effects on the economy were the FHA to
be shuttered.

“It highlights important aspects of FHA’s role, which is to step in, in times of extreme stress,” Zandi said in an interview. “There are only two periods of history where that’s been very important. One was during the Great Depression when FHA was established, and one was during the Great Recession.”

The Moody’s memo gained public attention recently when it was cited by congressmen, housing advocates and Galante during FHA hearings on the Hill.

Zandi said he’s in the process of expanding his initial modeling of the FHA with a more complete and expansive report, due out in late May or early June. The original memo examines what housing would have looked like following the financial crisis if the FHA hadn’t filled in when private capital fled. Zandi modeled a situation in which the FHA was shut down without warning on Oct. 1, 2010, and evaluated the resulting impact.

He predicted then that fixed-rate mortgages would have skyrocketed to about 12% because Fannie Mae, Freddie Mac and the private market would have been unable to fill the FHA’s void. Rates would have then drifted lower as the private mortgage industry attracted more capital. However, the MIs, still very thinly capitalized in 2010, would have been unable to substantially expand to meet the demand. The model predicted that median existing house prices would have fallen nearly 25% in 2011 without the FHA. Its absence, the memo said, would have brought the economy to its knees in a double-dip recession.

Zandi said little consideration has been placed on the FHA’s countercyclical role. With all the attention the agency is receiving now due to its condition, Zandi said it’s time for a more rigorous study of its role in different financial environments.


At the time Congress created the FHA, America’s homeownership rate stood at about 46%. Most Americans put off homeownership until they had accumulated substantial wealth, and short-term loans with balloon payments were typical, said Sara Rosen Wartell, president of the Urban Institute, who spent five years at the FHA early in her long housing career, and who has been to Capitol Hill twice recently to testify.

With the advent of the FHA, people of limited wealth could now become homeowners. The agency pioneered the low down payment loan with a long-term, fixed rate. By 1970, homeownership had risen to nearly 63%.

The FHA doesn’t lend money but rather provides mortgage insurance on loans made by approved lenders. It is the largest insurer of mortgages in the world, insuring more than 34 million properties since its 1934 Depression-era inception. FHA mortgages total about $1 trillion of the $10 trillion in mortgage debt outstanding.

Its government-backed insurance offers lenders protection against losses due to homeowners defaulting. The cost of the mortgage insurance is passed onto the borrower and included in the monthly mortgage payment. With five premium increases in recent years, the most recent on April 1, that insurance is becoming more expensive.

Unlike conventional loans, whose underwriting and down payment requirements were strengthened after the financial crisis, the FHA hasn’t changed its 3.5% down payment option except for those at the lowest end of its credit range, where a 10% down payment is now required.

After lending tightened in the wake of the financial crisis, the agency became the only viable option for homebuyers with very little cash or credit scores too low to qualify for a conventional loan. In the conventional market, it’s now typical for lenders to require a 20% down payment. Subprime products, meanwhile, remain essentially absent in a risk-averse lending environment.

While the FHA has historically served about half of the nation’s first-time homebuyers, that number later ballooned to nearly 75% of first-time buyers, according to a 2012 HUD working paper. It also serves low-income and minority borrowers who historically have been underserved by the private lending market. In 2010 statistics, the most recent data available via the Home Mortgage Disclosure Act, 60% of minority/ethnic homebuyers received FHA loans. Serving first-time homebuyers, the low- to moderate-income population, including minority/ethnic populations, is referred to as the FHA’s core mission.

Now congressmen are expressing concerns with what they call “mission creep,” although they are responsible for some of the creep. In 2008, Congress raised the FHA’s loan limits to $729,750 in high-cost areas of the country when they became concerned about overly tight credit in the wake of the financial crisis. But when the higher limit expired in October 2011, Congress opted to raise it back to $729,750 through the end of 2013.

Now housing advocates, congressmen and the FHA seem to agree that decreasing the loan limits is one way to entice private capital back into
the housing market. Support for lower limits appears strong.

“Now that the crisis has passed, and the market seems to be getting on stable legs, the FHA, and I think (Galante) agrees with this, needs to get back to their original position — back before the housing bubble, that is go back to their original mandate, which is first-time homebuyers and minority community lending,” said Sanders, the George Mason professor.

The FHA still could serve 95% of its historic targeted market even if the maximum FHA loan limits were reduced by nearly 50%, according to an FHA assessment report published in 2011 by George Washington University professors Robert Van Order and Anthony Yezer. They contend an FHA limit of $350,000 in high-cost markets and $200,000 in the lowest-cost markets is sufficient to satisfy more than 95% of the FHA’s targeted constituency.


The FHA has taken aggressive and decisive action — some of the most sweeping in the agency’s history — to improve the health and trajectory of the MMI fund, Galante said. Changes since 2009 are projected to have improved the economic value of the fund by at least $20 billion, she said.

“We’ve made lots of changes and I think all of them have made a large impact on the current and future trajectory of the (MMI ) fund,” she said.

Efforts to date include a tighter credit policy that eliminated seller-funded down payment assistance programs, which have cost the MMI fund more than $15 billion in economic value. It also increased down payment requirements to 10% for borrowers with credit scores below 580, although the agency admits banks and nonbank mortgage companies have shied away from lending to borrowers with FICO scores below 620. The FHA also added manual underwriting for borrowers with credit scores below 620 and debt-to-income ratios over 43%.

Galante said the agency also revised its “Total Scorecard,” the FHA’s automatic underwriting program, to recalibrate for risk.

Perhaps most notable, the FHA increased insurance premiums five times over the past four years, the most recent boost in response to the 2012 actuarial review. As of February, the increases had yielded more than $10 billion in additional economic value to the MMI fund, according to the FHA. It also revised its premium cancellation policy to now require borrowers to pay the insurance premium for the life of the loan.

Galante said the FHA also revamped its loss-mitigation programs. It boosted note sales via auction by selling nonperforming loans in pools at a market-determined price to investors in an initiative called the Distressed Asset Stabilization Program. Investors who buy the notes can then explore loss mitigation options with the homeowners.

Like others in the industry, the FHA also streamlined its short sales process — although some contend more adjustments are needed — and revised loan modifications to provide greater payment relief to borrowers in order to avoid foreclosures and reduce FHA claim costs.

This year, it plans to expand its pilot program in which properties secured by a nonperforming FHA-insured loan are offered for sale by the lender who has completed the foreclosure process. The properties are sold to third-party purchasers at a reserve price slightly below the outstanding balance without ever being conveyed to the FHA. The disposition method is expected to yield lower losses for the MMI fund than selling through a normal REO process that includes costs associated with preserving, managing and marketing the REO.

“I feel that we are in a good place right now,” Galante goes on. “I always say we have to work hard at the right balance between facilitating access to credit, helping the economy recover and ensuring we are taking on risk appropriately. I feel that today, now that we’ve raised premiums five times and we’ve tightened our credit policies, we really are in a place where we are well-priced for the risk we are taking on and I believe we will be generating out of these new books of business funds to replenish our reserves.”


But clearly some critics, even FHA advocates, contend
more must be done. Perhaps one of the FHA’s harshest
critics is American Enterprise Institute resident fellow
Ed Pinto who publishes a monthly “FHA Watch” newsletter which can be found on a website called

Pinto contends the FHA makes abusive, irresponsible loans with subprime attributes, disserving the nation’s working-class neighborhoods. It encourages families with low credit scores and high debt burdens to make risky financial decisions, he said.

Pinto did a study that shows 9,000 ZIP codes with a median family income below the metro area median have projected foreclosure rates equal to or greater than 10%. These ZIP codes have an average projected foreclosure rate of 15% and account for 44% of all FHA loans in the low- and moderate-income ZIP codes.

“I’ve gone back to 1975 and I have calculated the weighted average claim rate,” Pinto tells HousingWire. “Their weighted average claim rate has been 10.5% for 37 years. I don’t consider that a good record over a 37-year period. What happens is that 10.5% claim rate doesn’t get evenly distributed. It ends up in working-class neighborhoods.”

That rate of failure, Pinto argues, is unacceptably high.

Over its first 20 years, the FHA paid only 5,712 claims out of 2.9 million insured mortgages for a cumulative claims rate of 0.2%, Pinto said.

The FHA, he said, should look to the Department of Veterans Affairs, which has lower claim rates, for ways to do more responsible lending. He also notes that the VA doesn’t insure 100% of the loan and suggests that perhaps the FHA should lower its guarantee. Pinto also wants the FHA to price for risk, noting that it currently charges a risky borrower the same amount that it charges a more credit-worthy borrower.

Sanders, while perhaps less critical than Pinto, notes that the FHA’s predicament warrants additional reforms. The fact that lenders are unwilling to lend to borrowers with credit scores below 620, for example, should signal to the FHA that perhaps it shouldn’t be in that market, he said.

“If there was a taste in the marketplace for very low-income households or very low credit score households, the market would respond. Multifamily is where people with low incomes and low credit scores belong. I don’t know why the FHA thinks on the ownership side they have to fund that, other than for political reasons.”

Sanders refers to loans below a 600 credit score, or even below a 640 credit score, as “political loans” that put fragile households at risk. Still, despite some criticism, Sanders believes the FHA is moving in the right direction to improve its financial situation.


Before Galante there was David Stevens. Stevens, president and CEO of the Mortgage Bankers Association, headed the FHA from 2009 to 2011. Galante and Stevens both started at the FHA at roughly the same time during President Obama’s first term. Galante worked under Stevens, heading up the agency’s multifamily programs, and reported directly to him.

“I was running FHA and she was running multifamily. In my mind, her skills were superior to mine in that particular field because of her strong experience in that arena. It was a great partnership,” he says. Her knowledge freed up Stevens to concentrate on other areas, like policy changes. “I have nothing but the fondest admiration for Carol in both her knowledge of the issues and the quality of thought and engagement that she exemplifies as a leader at a very important time. Making her FHA commissioner following my departure was a natural (decision).”

Premium increases to stem MMI fund losses began under Stevens’ watch. He also initiated tighter controls and enforcement procedures to shut down irresponsible
FHA lenders.

Now at the MBA, where he has a large constituency of lenders, Stevens remains supportive of the agency. The MBA approves of implementing steps to ensure that the FHA will be strong in order to avoid excessive constraints being put on it, he told HousingWire. “If FHA doesn’t take care of its own issues, Congress will. That’s been made very clear.”


But lenders, he said, worry about the potential changes to the FHA’s enforcement policies. Last fall, the U.S. Department of Justice initiated a lawsuit against Wells Fargo, the nation’s largest FHA-approved lender, alleging the big bank “engaged in a regular practice of reckless origination and underwriting of its FHA retail loans over the course of more than four years … knowing that it would not be responsible when materially deficient loans went into default.”

DOJ, which claims HUD paid hundreds of millions in claims, seeks treble damages and civil penalties against Wells under the False Claims Act. The lawsuit sent shockwaves through the mortgage industry. Wells Fargo filed a motion to dismiss the case, alleging that the causes in the lawsuit are barred due to a previous settlement with DOJ over foreclosure issues. A hearing on the motion to dismiss was scheduled for April 17 as HousingWire went to press.

Stevens credits Galante for her work to come up with a new framework for representations and warranties that would narrow the definition of material defects so that if lenders make a minor error that isn’t material they wouldn’t be subject to indemnification or treble damages.

Galante said she has begun early conversations with lenders over enforcement issues.

“We put ourselves on a time frame to have deep conversations quickly,” Galante said. “We want to see if we can get to alignment. If we can’t, we can’t. You won’t know until you try. So we are putting some significant effort into that as we speak.”

Enforcement procedures might be adjusted in phases as some might require formal rulemaking and should involve consensus from the agency’s inspector general and DOJ, she said.

Stevens remains hopeful that alignment will come.

“Lenders who make serious mistakes in a loan file and submit it to the FHA should be held accountable and that indemnification should include all damages that are appropriate,” he said. “But for minor errors you can come up with a framework that can protect the integrity of the FHA program, ensure high-quality loans, but also encourage lenders to lend within the full scale of the credit boundaries.”


Julia Gordon, at the Center for American Progress, believes a lot of the tough talk from Capitol Hill is a distraction.

“The fact is that the FHA’s authorizing statute back in the ’30s was extremely broad,” she said. “The mission was simply to support the housing market.”

No one, no matter their political or ideological beliefs, thinks the FHA should be as dominant as it was at the nadir of the housing downturn, she said.

“The housing market has had some kind of government support since the time of the Great Depression and had been incredibly stable on a national level until PLS (private-label securitization) started to boom. That is where the instability and the volatility came from. Private capital is inherently less stable, and it is important to have some more stable institutions that pick up the pieces,” she said.

“Going forward, the question for people like Hensarling is ‘Do you want that institution to just be the FHA, which from time to time means the FHA is going to have a very big footprint, or do you want a government backstop behind the conventional market that can also take a role when private capital flees?’ ”

CAP supports an explicit government backstop in which private capital is in a first-loss position. Balance will be key for congressmen as they prepare FHA reform bills. “You could run the risk of reforming FHA out of its core business if you were to precipitously raise down payments or raise the level of credit score required. Then FHA would not be able to play the role that it has been playing,” Gordon said.

As HousingWire went to press, Randy Neugebauer, R-Texas, chairman of the Financial Services’ Housing and Insurance Subcommittee, said he expected FHA bills to be filed soon.

The MBA’s Stevens believes Congress will achieve the appropriate balance in any legislation passed. With one party controlling each House, compromise will be essential, he said.

“My own sense is that there may be bills that sound extreme. They may even make it through committee and maybe even through one House of Congress but we have a Democratic controlled Senate and a Republican-controlled House and a housing market showing signs of life. If a bill is going to go through both sides of Congress and be signed off by the president, it is going to have to be balanced. The debate is healthy. We need to have it.”

Galante, too, wants FHA reform legislation. She wants Congress, for example, to give her streamlined enforcement authority more in line with the nation’s Internet age. Under current statutory authority, if a national player is having issues in eight out of 10 places it operates, the agency must file eight separate enforcement actions instead of one.

Galante also seeks additional changes to the FHA’s reverse mortgage program to strengthen weaknesses. The program has bled funds, and is a big contributor to the MMI fund’s problems. Servicing rights is another area where Congress could help the FHA do its job better, she said. The agency wants the ability to transfer servicing rights if it sees that a servicer of a large portfolio isn’t following all of its rules.

Whatever happens, Galante said she feels good about the historic agency, its future, its reforms to date and the team running things.

“I would sincerely hope that people would not overreact to the challenges that FHA has, given the countercyclical role that it played and given all of the reforms that we have implemented and the adjustments that we have made,” Galante said.

“I would hope that people don’t overreact by changing the basic mission of the FHA,” she said. “I’m very optimistic about the future of the agency.”

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