By Dean Baker
September 2, 2009
If the FHA’s finances become shaky, it will be a major blow to the housing market.
Pending home sales jumped 3.2 percent in July, driven primarily by a 12.1 rise in sales in the West. Sales rose by 3.1 percent in the South, but fell by 2.0 percent in the Midwest and 3.0 percent in the Northeast. This pattern is consistent with many foreclosed properties being bought up by investors in California, Arizona, and Nevada. These are the states (along with Florida) that have the highest rates of foreclosure and the sharpest drops in home prices.
The rise in pending homes sales, along with data showing an upward trend in existing home sales and construction, plus the recent rise in the Case-Shiller index, is taken as evidence that the housing market is turning. This is likely a misreading of the market. The first-time buyers tax credit has brought many potential buyers into the market, persuading many people who might have bought in 2010 or 2011 to move their purchase forward to claim the credit. According to statements from the National Association of Realtors (NAR), first-time buyers have accounted for close to 40 percent of purchases in recent months.
The positive effect from the credit is likely to be exhausted in the near future, whether or not the credit is renewed, since most potential buyers will have already purchased a home. This will lead to a second slump in the market.
There may be some evidence for such a slump already in the pending home data and also the weekly mortgage applications index. The decline in pending home sales in the Northeast and Midwest could be an early indication that most of the families motivated to buy as a result of the tax credit have already bought a home. The modest decline in purchase mortgage applications, from already weak levels, is also consistent with this picture.
Ironically, the modest uptick in the housing market in the summer seems to have persuaded more homeowners to place their homes on the market. Many homeowners refrained from placing their homes on the market earlier this year, which is why the supply of homes for sale declined, in spite of a very slow sale pace. Now, the inventory of unsold homes is increasing, even though the sales pace has accelerated. If in fact demand does drop off again in the fall, this will create substantial downward pressure on prices.
One aspect of the market that has received relatively little attention is the growing importance of the Federal Housing Authority in mortgage financing. The FHA has largely supplanted subprime lenders, buying up 23 percent of the mortgages issued thus far in 2009. This should raise very serious concerns. In 2006, the FHA had contracted to just 3.0 percent of the market, so its current market share implies a huge expansion over a very short period of time.
The FHA typically requires just a 3 percent down payment. While this may be workable under some circumstances, this practice is likely to run into problems in the context of declining house prices and the most severe downturn since the Great Depression. Furthermore, given the huge ramp up in its lending in a very short period of time, it seems unlikely that the FHA has been able to adequately scrutinize the loans that it is buying.
The obvious risk is that the FHA suffers large losses from a wave of defaults and then requires a bailout from Congress. While the size of a bailout may not be large relative to the bailouts of AIG, Fannie and Freddie, the crippling of the FHA as a lender would be another blow to the housing market.
It would also be a serious political blow to efforts to ensure access to mortgages for moderate-income families. In the current political environment, if the FHA requires a bailout, it is likely to come with very serious strings attached which are likely to limit its ability to buy mortgages in the future. This problem could have been easily prevented if the FHA used rent-based appraisals in determining whether it would buy loans.
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.