Recent changes to Federal Housing Administration standards for approving lenders are essential, but still not enough to address the agency's financial shortfall, says American Enterprise Institute fellow Edward Pinto. Pinto and the AEI reignited the debate over the FHA's financial stability when it commissioned a study from the University of Pennsylvania Wharton School that claimed the the agency was undercapitalized by up to $100 billion over the long term. Pinto calculates the FHA is undercapitalized by $35 billion to $53 billion. The only significant change to strengthen the FHA's insurance fund — which it uses to pay claims — is the lowering of the maximum allowable amount of seller concessions, or how much the seller contributes to the down payment or closing costs, Pinto says. The FHA says the reduction is in response to current concession levels, which creates incentives to inflate the appraised value of a home. Most lenders, including FHA-insured lenders, allow up to 6% in seller concessions. Pinto says seller concessions of 6% have a substantially higher claim rate that those at 0% or 3%. "This will actually have a substantial impact. Of all the changes, it's the one that has the most forward impact," he says. The new rule that forces lenders to reimburse the FHA for an insurance claim if the agency finds that the lender "knew or should have known" of any fraud will only have minor effects because most of those effects are already factored into the FHA's business model, Pinto says. Lenders would be on the hook for reimbursement if the loan defaults within five years of origination. Unlike some who want the five-year window shortened, Pinto has no quarrels with the window and calls it "reasonable." In setting a standard in which the FHA has to demonstrate fraud or misrepresentation, the FHA has set a high bar for itself. "That's a pretty high standard in my opinion, so I think that counterbalances the five-year period," Pinto says. Pinto, who just launched FHA Watch, an online publication that spotlights the financial status of the FHA, is a harsh critic of the agency. He is also a former Fannie Mae executive vice president and chief credit officer. Pinto says the FHA should stop competing with the private sector in financing mortgages that are priced above an area's median house price. "They should focus on helping people accumulate equity in their homes, which means they need to balance their low down payments with the excessively long loan terms of 30 years so that people build equity through the upfront down payment of amortization and not through house price inflation," he says. "FHA has relied on house price inflation, as has much of the mortgage market, for way too long," he adds. "We need to get back to where the mortgages themselves stand on their own regardless of what happens with house price inflation or deflation." Pinto recommends increasing the FHA's capital ratio minimum to 4% and computing it in a manner similar to the private sector's ratio. The FHA's ratio stands at 0.24%, well below the federally mandated minimum of 2%. "They're trying to grow their way out of it, which I think is incorrect," Pinto asserts. "They need to shrink their share and re-target back to their original mission. This will help taxpayers. Growing their way out will create bigger problems." Write to Justin T. Hilley. Follow him on Twitter @JustinHilley.