The First-Time Homebuyers Tax Credit Helped Sink the FHA

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Friday, 14 December 2012 16:30

The NYT had an article on a new study by Edward Pinto at the American Enterprise Institute which found that a high percentage of the loans the FHA insured in 2009-2010 were high risk loans that are likely to end in foreclosure. Based on its findings, the study criticized FHA lending practices. It argued that they were both leading to large losses for the program and resulting in large numbers of homes in foreclosure, which is devastating both to the homeowners and the communities in which they live.

Remarkably, the study does not take into account the impact of the first-time homebuyers tax credit. This credit had the effect of temporarily inflating house prices, especially in the bottom end of the market where FHA loans were concentrated. It was 100 percent predictable that a large percentage of these loans would end in default since house prices were certain to fall once the tax credit ended.

It is misleading to generalize from this experience that the FHA has been reckless in its lending policies. In fact, at the peak of the bubble in 2002-2006 the FHA's market share plummeted as low and moderate income borrowers found that they could get much more lenient conditions from private lenders. While many of the points in the study are well-taken (it does not make sense to encourage people to leverage themselves heavily to buy a home where they will have great difficulty meeting the payments) the FHA does not have the history of recklessness that the piece implies.