FHA'S Default Insurance Program Strategically

FHA'S DEFAULT INSURANCE PROGRAM STRATEGICALLY PROVIDES FOR OR CREATES PUBLIC VALUE: A CASE STUDY This work in writing has as its objective the investigation of whether the Federal Housing Administration's Default Insurance Program (DIP) effective meets the stated purpose of creating public value by encouraging financial institutions to increase lending for mortgages to provide affordable home ownership to those families unable to quality under standard industry criteria.

Theoretical Framework The theoretical framework for this research is the concept that government security to mortgage lenders creates a situation in which financial institutions are more willing to lend money to low-income homebuyers. In turn, when financial institutions have a greater incentive to lend money to homebuyers who otherwise would not qualify for a mortgage, public value is enhanced via increased homeownership leading to expansion of the nation's economy.

Methodology The proposed research will be conducted an in-depth literature of the default insurance program by reviewing previous studies, as well as statistical data to determine the value that has been created for the public with regards to the expansion of homeownership and even the expansion of the construction and housing industries. Case Study Type The case study structure that will be used for this research will be a linear-analytic approach.

This structure is being used because it is most common case study structure, and it allows for the progression from an overview of the issue that is being examined to the analysis of the information and data that are available, and finally to conclusions to be drawn from the analysis that takes place.

Hypothesis The stated hypothesis in this study is that the default insurance program through the Federal Housing Administration does create value for the public by allowing greater levels of homeownership and allowing for an overall expansion of the housing industry in the United States. Background of the Study The work of Quigley (2005) reports that prior to the 1930s depression, "…home mortgage instruments were typically of short terms (3-10 years) with loan-to-value ratios (LTVs) of sixty percent or less.

Mortgages were non-amortizable, requiring a balloon payment at the expiration of the term. The onset of the Great Depression engendered a liquidity crisis beginning in 1930, preventing renewal of outstanding contracts. Other borrowers were simply unable to make regular payments. The liquidity crisis affecting new mortgage loans, together with elevated default rates on existing loans, had catastrophic effects upon housing suppliers as well as housing consumers." The following Figure shows the U.S. Housing Starts 1900-2004. Figure 1 U.S.

Housing Starts, 1900-2004 (thousands of units) Source: Quigley (2005) The Federal Housing Administration (FHA) was established in 1934 for the purpose of overseeing a program of home mortgage insurance against default." (Quigley, 2005) Proceeds of a fixed premium charged on upaid loan balances funded the insurance which were managed as a mutual fund following revenues being deposited in Treasury securities. This product was diffused across the country and this required standardization on a national level of underwriting procedures.

Resulting was a requirement for appraisals and credit histories of borrowers with reported and systematic evaluation of financial capacities.

The modern standardized mortgage, according to Quigley (2005) "was born." In the beginning loan amounts were under a restriction of a $16,000 limit however the median price for housing is stated to have been "less than $5,304." (Quigley, 2005) The VA loan program was passed in 1944 as part of the GI bill and it is stated to have "rapidly evolved form a temporary 'readjustment' program to a long-range housing program available to veterans." (Quigley, 29005) Quigley reports that the provision of these two programs in the form of insurance and mortgage guarantees brought homeownership opportunities to middle class American households in a short space of time." (2005) It is reported that over time the mortgage originations insured by the FHA has experienced a decline from approximately 25% in 1957 to a mere 2% in 2003.

Variations in policy are attributed for these differences in rate of mortgage originations over time. The following chart shows the value of FHA & VA Originations/Total Originations 1939-2004. Figure 2 Value of FHA and VA Originations/total Originations 1939-2004 Source: Quigley (2005) Literature Review I.

Benefits of Homeownership The work of Herbert and Belsky (2008) entitled "The Homeownership Experience of Low-Income and Minority Households: A Review and Synthesis of the Literature" reports that during the last half of the decade of the 1990s and the first half of the decade of the 2000s "the economy, capital market innovations, industry outreach and government regulation and policy all converged to drive significant increases in the national homeownership rate." (Herbert and Belsky, 2008, p.

5) The homeownership rates among those classified as very low-income households, as well as African-American and Hispanics is reported to have risen by "6.4, 6.6, and 8.7 percentage points, respectively." (Herbert and Belsky, 2008, p.5) It is additionally reported that the increases in homeownership which were quite high were even more surprising as they came just following more than ten years of "stagnant or declining homeownership rates." (Herbert and Belsky, 2008, p. 6) Lenders had by 2006 greatly relaxed various constraints on underwriting loans that had historically created great challenges for low-income households in achieving homeowner status.

Included were low downpayment loans, loans to those with bad credit history and no credit history as well as less requirements in the area of income documentation and asset requirements, along with lower requirements for reserve and products that served to lower the beginning payments with the added risk of increasingly higher payments at a later date.

(Herbert and Belsky, 2008, paraphrased) Herbert and Belsky (2008) report that in some cases homeownership "has made families worse off." (p.7) This is stated to be due to the record numbers of foreclosures which are stated to be "driven by subprime loans, which are disproportionately loans to low-income and minority borrowers." (Herbert and Belsky, 2008, p.

7) It is additionally reported that while the Federal Reserve Bank of Boston researchers stated conclusions that "foreclosures in the range of 20% of all subprime purchase loans made in Massachusetts between 1989 and 2007 may be likely…even this prediction is an extrapolation from a period largely without significant home price declines or a significant relaxation of underwriting standards. Furthermore, even if buyers are able to maintain their housing payments, they may be stuck in poor-quality housing or may devote an excessive share of their income to housing." (Herbert and Belsky, 2008, p.

7) Questions that remain is whether many low-income and minority buyers have actually been able to realize the wealth accumulation, residential stability, and improved life outcomes for children that homeownership has promised." (Herbert and Belsky, 2008, p. 8) The benefits of homeownership includes the financial benefits generated by owning a home as homeownership serves "as a vehicle for wealth accumulation, both through appreciation in value and through the forced savings associated with paying down outstanding mortgage principal." (Herbert and Belsky, 2008, p.

7) The one unique aspect of homeownership is stated to be that it is one of the few leveraged investments available to households with little wealth, enabling homeowners with very little equity in their homes to benefit from appreciation in the overall home value." (Herbert and Belsky, 2008, p. 8) Statistics show that when one purchases a $100,000 home with a $5,000 downpayment the outcome is "100-percent return on his or her investment if home prices rise by a mere 5% in the first year of ownership.

This appreciation makes homeownership especially appealing for households that have low initial savings, such as low-income households.

Wealth accumulation through homeown-ership is also enhanced by tax law provisions that shield most appreciation in home values from capital gains taxes and that allow homeowners to deduct mortgage interest (if itemizing deductions exceeds their standard deduction)." (Herbert and Belsky, 2008, p.8) Herbert and Belsky state that the following is critically important to consider the fact that the: "…high transaction costs associated with buying and selling homes relative to renting are a key factor offsetting any financial returns to homeownership from appreciation of a leveraged asset.

In fact, real estate agent fees alone are typically 5 to 6% of the sales price. Buying a home entails mortgage fees and closing costs that can amount to several percentage points of a home's value. In addition, sellers often face transfer taxes and legal fees and may have to help buyers cover cash closing costs. Thus, if owners are forced to move either shortly after buying or during a down market, these transaction costs can greatly erode or eliminate any financial returns to homeownership.

It is not uncommon for the combined costs of buying and selling a home to total 8 to 10% -- or more -- of the value of a home." (Herbert and Belsky, 2008, p. 9) There are three ways that homeownership serves to provide a contribution to the financial well-being 1. First, owner occupants are insulated from rapidly rising housing costs, particularly if they have fixed-rate financing.

With long-term financing, the real cost of housing generally declines over time, so homeowners can have greater capacity for accruing savings in other financial assets or can enjoy a higher level of consumption. 2. Second, the deductibility of mortgage interest and property tax payments serves to lower the after-tax cost of homeownership, also contributing to owners' ability to increase savings or consumption. Many low-income owners may not benefit from these provisions, however, because the standard deduction often exceeds interest and property tax 3.

Third, homeownership allows a borrower to tap into secured lending against his or her home, which, all else equal, is often at a lower rate of interest than unsecured lending. All these financial benefits are possible but in no way assured. As discussed in the following text, the proper way to view homeownership is as an investment that carries with it significant risks and uncertainties.

For any number of reasons, homeowners can end up losing money on their homes or earn less of a return than if they had rented over some period." (Herbert and Belsky, 2008, p. 9) A second area of benefits is stated as social benefits. Herbert and Belsky report that one primary social benefit is that "owners are thought to have higher satisfaction with their homes, in terms of both the housing unit itself and the neighborhood where they live.

In theory, this observation could flow from the fact that owners have greater ability and incentive to invest in their homes to suit their tastes." (2008, p. 10) In addition, it is held that homeowners possess higher self-esteem "due to both the higher social status associated with homeownership and the sense of accomplishment that result from having achieved a significant life goal." (Herbert and Belsky, 2008, p. 10) Lastly, stated as an important social benefits of homeownership is "…better life outcomes for chil-dren who grow up in owner-occupied homes.

Homeownership is thought to benefit children by several mechanisms. It may enable greater residential stability, which benefits children by provid-ing a stable social and educational environment." (Herbert and Belsky, 2008, p. 11) II. Factors that Affect the Realization of Homeownership Whether the benefits of homeownership are realized is dependent upon various factors including those stated as follows: 1. When (age and timing) household heads first become homeowners. 2. Where they choose to buy. 3. How much the household spends on housing. 4. The condition and age of the home they buy. 5.

How much they reinvest in maintaining and improving their homes. 6. The mortgage products they can qualify for, have access to, and choose. 7. If and when they refinance mortgages or tap into home equity. 8. The return of alternative investments and the cost of renting instead. 9. Whether income or budget shocks force them to default on their mortgage loans or house price declines spur them to do so. The timing of purchases and sales relative to house price cycles. 10. The capacity to benefit from federal tax advantages. 11.

How often they move, their tenure choice, and the transaction costs of moving. (Herbert and Belsky, 2008, p.

11) Herbert and Belsky, (2008) state that practically all the factors that are contributors to the outcomes from choices of tenure "are likely to be strongly influenced by a household's income, race, and ethnicity." (p.11) It is stated as well that while mortgage interest can be deducted on federal income taxes providing incentive for homeownership, lower income households are stated to "derive fewer benefits form this provision both because they have lower marginal tax rates and because their itemized deductions may be small relative to the standard deduction, reducing the chance that they will choose to itemize their deductions." (Herbert and Belsky, 2008, p.11) Figure 3 - Conceptual Model of Lifetime Returns from Tenure Choices Source: Herbert and Belsky (2008) Herbert and Belsky (2008) state that there are three critical factors that influence the experiences and decisions of low-income and minority home-buyers after they purchase their home and specifically state the following factors: (1) First and foremost is the question of how long these owners maintain homeownership, because many of the financial and social benefits of homeownership are derived from residential stability.

(2) Second is the experience of these owners both in refinancing their primary mortgage and in using debt to tap their accumulated home equity, because these decisions have important implications for the ongoing costs of homeownership and whether these owners are able to accumulate wealth over time; (3) Third, differences in low-income and minority homeowners' tendency to invest in maintenance and improvement to their homes also influence homeownership outcomes. III.

Government Creation of Place and Value The work of Mark Moore "Creating Public Value: Strategic Management in Government" provides a description of what Moore refers to as a 'strategic triangle' of public value.

It is suggested by Moore that corporate strategy can be modified for use in the private sector and make provision of a framework that is useful in the realization of pubic value by managers in the public sector in the integration of substantive judgments of what would serve to be both effective and valuable as well as the integration of an analysis that is comprehensive of political expectations and assessing what is possible in the operations.

Moore holds that these specific criteria are the measures that can be used by public managers as to the public value of such actions. Considerations are necessary concerning the legal and political support of the same and the feasibility of their administration and operation.

Moore additionally holds that public administration is required to make the determination of what can be expected from public managers and as well public administration must make identification of resources that serve to provision public managers with the information and tools needed to provide a response to these expectations and for developing more effective methods to provide rapid response to ever-shifting situations thereby exploiting these situations to the advantage of the public.

Specifically Moore states "In seeking public value, we come finally to what many believe is the essence of management: the self-conscious, skilled deployment of legal, financial, material, and human assets to produce concrete results" It is suggested by Moore as follows "It is one thing for managers to have visions, and still another for them to mobilize a flow of resources to their enterprises. But the heart of management lies in delivering the envisioned value" (193).

Place is stated to be important to "individuals, to families and to all collectivities of humans." (Kirlin, 1997, p. 167) This is because individuals "live, marry, procreate, learn, work, participate in community affairs, play, worship, and die in specific geographical places. Specific governmental policies shape all these and other facets of life." (Kirlin, 1996, p.

167) Information, values and economic opportunities undoubtedly are influenced by global dynamics, but those factors do not so much reduce the importance of place as change in the way in which governmental actions will be used to enhance the value of place. Living in an open inclusive society." (Kirlin, 1996, p.

167) Kirlin goes on to state that the types of value created by public and private action are "categorized as related to place, complex systems, or goods and services." (Kirlin, 1996) Kirlin states a belief that the primary function of governments is "increasing the value of place." (1996) Place is stated by Kirlin to be important both economically and politically. IV.

Functions Government Performs for Society Three functions are performed by government for society: (1) The first role is "…constituting an effective government"; (2) The second role is political choices that define and protect the character of the community; (3) the third role is 'service delivery'. (Kirlin, 1996, p. 168) Kirlin states that "advocating the creation of value through governmental action is a useful beginning to what is needed to transform systems of governance." (p. 173) It is reported that the opportunities to create value "can be understood as a matrix defined by two dimensions.

One dimension consist of five arenas for governmental action, while the second dimension consists of three types of value that can be created." (Kirlin, 1996, p. 173) It is reported that the arenas are "social constructions where collective choice and action regarding government are possible." (Kirlin, 1996, p. 173) Arenas are stated to be "locations" defined socially, through which collective choice and action are possible." (Kirlin, 1996, p.

173) Kirlin states that in contrast, "the types of value involve analytical distinctions among the consequences of these choices and actions…" and therefore value distinguishing requires categories of products while distinguishing arena distinguishing requires categories of processes. (Kirlin, 1996,, paraphrased) The five arenas of governmental action are stated to be those of: (1) constitutional; (2) jurisdictional and civic infrastructure; (3) Policy strategy and policy infrastructure; (4) program implementation; and (5) organizational level/managerial. (Kirlin, 1997, p.

174) It is reported that 'place' values are inclusive of effectiveness of political structures and civic institutions, individual, property and other rights, competitive position in global markets and the factors that influence the quality of life in an area, such as the environment, housing, affordability, personal safety, mobility, and opportunities for individuals to shape their own destinies." (Kirlin, 1996, p.

175) Complex functional system values include effectiveness of linkages among public, private, and nonprofit organizations required for successful action in most arenas; extent of access to those structures; and capacity for learning and adaptation." (Kirlin, 1996, p. 175) Three proposals for creating value are stated to include the following: (1) standardizing geographical arenas for governmental decision making at national, state, regional, city and neighborhood levels; (2) establishing a constitutional right to certainty of actions that will comply with governmental policy; and (3) using case managers to deliver social services, perhaps in a capitated system. (Kirlin, 1996, p.

178) There is stated to be "extreme fragmentation of governmental policy making" and it is reported that the negative consequences arising from this fragmentation include: (1) inability to achieve coherent coordinated action; (2) confusing, incomprehensible government; (3) inaccessible, unaccountable governments; (4) total governmental expenses that are larger than commonly understood; and (5) Large costs imposed on society to participate in fragmented arenas and to comply with conflicting parties. (Kirlin, 1996, p.

179) It is reported in a HUD Issue Brief that FHA has "…traditionally been the mechanism used by borrowers who have difficulty obtaining mortgage financing in the private conventional market. It has long been recognized as the major source of funding for first-time, low-income, and minority home buyers.

As indicated by the following points, the combination of a strong economy and significant program and policy changes has allowed FHA to expand on its traditional role." (2000) It is stated in the HUD Issue Brief that the share of FHA-insured has increased "from 67% in 1993 to 82% in year 2000." (2000) FHA has assisted 4.3 million individuals purchase their first home during that same period. It is reported as well that the share of FHA home loans provided to African-American and Hispanic homeowners increased from 67% in 1993 to 82% in year 2000.

The share for all minorities increased from 22.5% to 41.8% during this period. (HUD Issue Brief, 2000) FHA insured 21% of all home purchase loans originated in metropolitan areas during 1999 and insured 42% of loans for African-American and Hispanic borrowers. Three out of ten home loans originated in underserved areas.

It is reported that FHA has maintained its role in both the low income and minority mortgage market and FHA's share of the mortgage market and while the conventional market has improved its performance in affordable lending no replacement of FHA's important role for providing access to mortgage credit for historically underserved borrowers.

Because FHA insurance is important for these groups and large housing gaps exist there have been various steps taken by HUD to "enhance the usefulness of FHA insurance." (HUD Issue Brief, 2000) Included in these enhancements are: (1) lower insurance premiums; (2) higher loan limits; (3) consolidation and streamlining of loan process to increase speed and improve consistency; and strengthening of the appraisal process.

(HUD Issue Brief, 2000) FHA has also introduced "automated underwriting through Freddie Mac and Fannie Mae and has been developing and testing its own FHA mortgage scorecard." (HUD Issue Brief, 2000) The Federal Housing Enterprises Financial Safety and Soundness Act of 1992 is stated to affirmed and strengthen HUD's role as mission regulator for Fannie Mae and Freddie MAC and the government-sponsored enterprises (GSEs) in the secondary mortgage market." The primary responsibility under the 1992 GSE Act has been "the establishment of goals for the GSE's purchase of mortgages for targeted groups of borrowers" including low- and moderate-income families, families living in underserved areas and special affordable families (very low-income families and low-income families in low-income areas)." (HUD Issue Brief, 2000) The work of Herbert, Haurin, Rosenthal, and Duda (2005) in the work entitled: "Low-Income and Minority Borrowers and Neighborhoods" homeownership rates are presently at "historically high levels for all segments of the U.S.

population…" however "dramatic gaps in homeownership rates have been stubbornly present over the last several decades, and even increased somewhat during the decade of the 1990s.

As of 2004 the rate of white homeownership was 76% and African-American and Hispanic homeownership rates remained below 50% and the Asian rate was 60%." (Herbert, Haurin, Rosenthal, and Duda, 2005) Understanding the determinants of homeownership rates and gaps is important because homeownerships wisely believed to provide a variety of benefits for both individuals and communities." (Herbert, Haurin, Rosenthal, and Duda, 2005) It is reported that homeownership "expands individual opportunities to accumulate wealth, enables a family to exert greater control over its living environment, creates incentives for households to better maintain their homes, and may benefit children of homeowners.

Homeownership also benefits local neighborhoods because owner-occupiers have a financial stake in the quality of the local community." (Herbert, Haurin, Rosenthal, and Duda, 2005) Federal policy that affects housing is dominated by "indirect off-budget activities -- tax expenditure policies and credit, insurance and guarantee programs -- rather than the direct subsidy of housing production or the payment of shelter allowances to be deserving households." (Herbert, Haurin, Rosenthal and Duda, 2005) John Alford writes in the work entitled " Defining the Client in the Public Sector: A Social-Exchange Perspective" that those who seek government reform "urge the adoption of a private-sector-style 'customer focus,' but critics see it as inappropriate to the public sector" on the basis that it "devalues citizenship." (2002) According to Alford (2002) there are actually two sets of differences "…between private sector customers and the 'publics' of government organizations." Those two are stated to be: (1) firstly, that which has to do with 'who performs' the primary functions referred to above -- expressing preferences and receiving goods or services; (2) the second has to do with the 'nature of those functions.

(Alford, 2002) Each of these in the private sector are stated to be performed by the same individual or the customer however in the public sector they are "…asymmetrically divided between two categories of actors -- the citizenry and clients -- who together constitute the primary distinction in this typology." (Alford, 2002) The government delivers value and that value is "consumed by citizens (who receive public value) and by clients (who receive private value)." (Alford, 2002) Alford reports that the function of stating choices about the value that the government should produce is carried out mainly by the citizenry through the process of political democratic process which is a process that results in the citizenry having the overriding say concerning public and private value.

The difference in public and private business is "what they exchange and the type of exchange." (Alford, 2002) It is necessary to understand not only the various types of clients in terms of their expectations and what they have to offer -- and it is this that makes provision of a framework that is useful in tailoring the value created to the group or groups at focus. FHA has tailored mortgage loans in cohesion with a government default insurance funding for those who meet the qualifications for such mortgage loans.

Historically this has been a successful strategy in assisting low- to moderate-income families and minority families in attaining homeownership status and in growing their wealth through building equity in their home. However, this all changed with the recent mortgage loan crisis which has been characterized by subprime loan failure. Subprime loans already put those in these type loans at a deficit in the area of equity building and added to this is the falling prices of homes which further robs the homeowner of equity.

Following approximately three decades of progress sit is reported that "real median household incomes will almost certain end the 2000s lower than they started" and additionally, real household wealth is stated to have fallen from $503,500 to $486,600…" (The Joint Center for Housing Studies of Harvard University, 2010) It is furthermore reported that "debt has never been higher relative to home equity…" as following a $8.2 trillion drop in housing wealth since 2005 mortgage debt was at 163% of home equity at the beginning of 2010." (The Joint center for Housing Studies of Harvard University, 2010) The combination of job losses and lower prices on housing the factors that brought first-time homebuyers into the market is attributed to result in poor mortgage loan performance.

At the end of FY 2001 there were 6.6 million FHA-insured single-family loans outstanding at the end of FY 2001. FHA insured over a million single-family mortgage loans in 2001 with seventy percent of those being for purchase of a home and the remaining for refinancing a home. In 2000 FHA insured only 920,000 loans with 92% being for purchase of a home. In the present FHA only insures.