Government-Backed Mortgages at Record High

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By Dean Baker

September 23, 2009

Construction of multi-family units jumped in August.

The Mortgage Bankers Association reported that its application index for government-backed mortgages rose to a record level last week. Applications for government-insured mortgages accounted for 45.7 percent of the market, the highest share since November of 1990, a period when the economy was also in the middle of a recession.

The rise in the government-insured share is striking in the current market. The Federal Housing Authority (FHA) is the main actor among government insurers, having insured close to 25 percent of the mortgages issued this year. The Veterans Administration (VA) has seen a growth in its market share this year as well.

The government agencies have essentially replaced the subprime portion of the market, which has largely disappeared with the collapse of the housing bubble. While subprime mortgages allowed many homebuyers to purchase homes with little or no down payment, with the demise of this sector most homebuyers would have to put 10 percent down to get a standard-conforming mortgage. However, the FHA and VA loan programs allow homebuyers to purchase homes with 3.5 percent down payments. As a result, they have seen a huge surge in demand in the last two years.

As has been widely reported, the FHA has taken substantial losses on many of its recent mortgages and will fall below its 2.0 percent capital requirement in its end of the fiscal year report. This may lead to pressure to tighten its lending practices, which could be another force constraining demand in the market.

It is worth noting that the FHA (like Fannie and Freddie) might have avoided some of its recent losses if it had adopted a system of rent-based appraisals in deciding whether to back mortgages. Specifically, it could have refused to guarantee mortgages in cases where the purchase price exceeded some multiple (e.g. 15) of appraised annual rent. This would have prevented the FHA from insuring mortgages used to buy houses at prices that had been inflated by the housing bubble and were therefore likely to fall in value as the bubble deflated.

Given the extraordinarily high unemployment rate, higher than normal rates of default were inevitable. However, the probability of foreclosure and the loss on each foreclosure both increase enormously when the home is worth less than the amount owed on a mortgage. Rent-based appraisals would have substantially reduced this risk.

Both housing permits and starts increased in August, but the rise was entirely attributable to an increase in multi-family units. Permits overall rose by 2.7 percent in August while starts rose by 1.5 percent. However, permits for single-family units fell by 3.0 percent, with starts dropping by 1.6 percent.

The increase in construction, which was most pronounced in the Northeast, is somewhat perplexing, given the extraordinarily high vacancy rates in most markets. They are two likely explanations for the increase. First, starts of multi-family units are still at very low levels. The annual rate in August was only a bit more than one-third of the rate at the peak of the housing bubble in 2005. Movements around a low bottom would not be surprising.

The other reason why multi-family starts may take place even in a glutted market is that developers have often made substantial investments in a development even before they actually undertake construction. They may have incurred substantial costs to buy land, tear down structures, and hire architects and engineers. These costs cannot be recovered if they do not carry through the project. Therefore with the economy and housing market looking somewhat better than it did earlier this year, it should not be surprising that many developers would try to move ahead with the projects they have planned. It is also possible that the easing in credit markets has made it possible to get financing that was not previously obtainable.

The increase in building is not necessarily good news for the housing market. The market remains glutted and it will take years of population growth and/or substantial price declines to bring supply in line with demand. If there is a substantial upturn in construction, this adjustment process will take longer.

Dean Baker is Co-Director of the Center for Economic and Policy Research, in Washington, D.C. CEPR's Housing Market Monitor is published weekly and provides an incisive breakdown of the latest indicators and developments in the housing sector.