Set Up for Failure

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W. Scott Frame, Kristoper Gerardi, and Joseph Tracy write,

The extinction of the private subprime market and the rapid rise of the government insurance programs may strike many as a largely positive development. After all, it was the subprime segment of the mortgage market that triggered the global financial crisis and subsequent Great Recession as subprime loans defaulted at an astronomical rate during the housing bust. However, while government-insured mortgages are typically underwritten with more rigor and discipline than private subprime loans, they are not low-risk loans. The combination of high leverage and low credit scores documented above translates into extremely high default rates. The table above shows that five-year cumulative default rates (CDRs) by year of origination varied between 5 and 25 percent over our sample period. To put these numbers into perspective, the five-year CDRs associated with loans insured by Fannie Mae and Freddie Mac (the housing government-sponsored enterprises, or GSEs) are typically an order of magnitude lower. According to our calculations, the 2002 and 2009 vintages of GSE loans had five-year CDRs of approximately 2 percent, while Ginnie Mae’s same vintages had five-year CDRs of almost 10 percent and 13 percent, respectively.

Pointer from Mark Thoma.

The Federal Housing Administration, FHA, sets up many borrowers to fail. One could argue that these borrowers put up so little of their own money that this is a worthwhile risk from their point of view. It is the taxpayers that are being set up to fail.

11 thoughts on “Set Up for Failure”

  1. People don’t seem to recognize maybe they don’t grant loans as liberally because they don’t have to. If the private sector did this they would call it credit discrimination.

  2. The Federal Housing Administration, FHA, sets up many borrowers to fail.

    Then how come the FHA did not need a bailout during the housing crisis? Arguably they had the cleanest balance sheet of any of the institutions in early 2009. (Not that I agree with the FHA but I still see the housing bust as a private sector failure.)

      • True maybe, but I have not seen Arnold use the null hypothesis on the housing boom & bust. His writing and links are always articles about how the Federal government caused the boom/bust and never really questioning the hypothesis. (Nor doing a lot of refuting other evidence from Rortybomb or others.)

        The null hypothesis should be the housing boom and bust was not caused by the Federal Government. But I have seen this proof. (This does not mean I want FHA to exist.)

        • I think THIS is the null hypothesis:

          Google: “fed funs rate versus mortgage rates”

          Look at images. Obviously they created the boom and caused the bust, until disproven otherwise.

          • It has been disproven about a thousand times.
            You just ignore the simple fact that the housing boom was caused by the fraudulent acts of the investment banks combined with the fraudulent acts of the credit rating agencies.

            These would have happened regardless of the Fed funds rate. As has happened in the past with the S&L crisis.

            Fraud does not care about the Fed funds rate.

    • The FHA was subprime before everyone started twisting subprime to mean what the investment banks did, tight lending on low cost low income housing, with risk but limited risk. Loose lending will always drive out tight lending and garner the market until the bad debts come home and loose lending vanishes, leaving tight lending all that’s left.

      • “Loose lending will always drive out tight lending ”

        Unless perhaps your cost of capital is lower. Correct?

  3. Geez.

    No reason to bother to look at default rates for the separate programs; nor look at the long, successful history of the FHA and VA.

    Nah, let’s just concentrate on high LTV’s(Horror!) and alleged low credit scores(600, are you kidding me!).

    Little math test here:

    Which loan contains more risk?

    A 3.5% down FHA loan with a large upfront mortgage insurance payment(yeah, I get it is rolled into the loan) that also contains monthly mortgage insurance payments

    or

    A 20 % down loan with a piggyback HE loan that contains no mortgage insurance.

    I remember more than 30 years ago when the minimum credit score for FHA loans was 560. I missed the housing bubble caused by that.

  4. But kudos(so far) to the sight. I have been expecting to see the latest monstrosity from Kudlow and Stephen Moore on how the Community Reinvestment Act destroyed the world.

    Once again continuing their long streaks of never being right about anything, and frequently lying to get to the point where they are dead wrong.

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