At the FHA, an American Dream Narrowly Conceived

While some may argue that America is an inherently suburban nation, full of citizens who want their own homes and yards, they forget that the federal government’s subsidization of this the past eight decades has likely distorted preferences. In 1934 the Federal Housing Administration (FHA) was formed to boost a lagging market, and was soon insuring long-term mortgages that required little money down. Over this time it favored housing in suburbs rather than cities, and following these incentives, consumers began moving out to them, transforming farmlands into the subdivisions of today. Although with time the FHA adopted a more urban focus, perhaps to atone for past redlining policies, it still disproportionately favors suburban-style housing. The comparison of mortgages insured for single-family versus multi-family units in the history of the FHA and HUD are a whopping 34 million to 47,205, and ratios are little different even now.

But in a recent turnaround spurred by changing consumer demands, these FHA policies were shifted by HUD to narrow the playing field. Enacted in September, they grant mortgage insurance for condo buyers with down-payments as low as 3.5%, the percentage now allowed for single-family homes. Before then, condo buyers often needed 20% down or more and excellent credit to get loans from banks, and they had to pay higher interest rates. These, along with strict liability rules, discouraged such buyers, which then reduced values for existing condos and prevented new construction.

The shift in policy, according to Megan Booth, has long been overdue not only because of these market changes, but because of a social climate that increasingly values high densities, mixed uses, and urbanism in general. A policy representative for the National Association of Realtors, Booth said she has heard time and again how Congressmen who dictate FHA policies will speak of the importance of density for the economy and environment, only to enact the same tired incentives for suburbanization. The new policy, she explains, is a refreshing shift from longstanding traditions, but not enough of one, since after reforms the FHA will still not insure condo buildings with more than 35% retail space (up from 25%, but with exceptions). Nor will it insure ones that are more than 50% investor-owned (up from 10%). These restrictions have been established to mitigate risk and encourage owner-occupancy, even though, according to Booth, there is no proof of underperformance in condos of this sort. Rather, the restrictions just prevent construction of ones that are greatly desired but seldom built, because of faulty market interpretations by the FHA. These condo reforms also will not be permanent, but will be up for review in August 2014.

An important question raised by this is less what type of housing the FHA should insure, than how big its role should even still be in the mortgage market. While Fannie Mae and Freddie Mac were blamed for generating the toxic securities that caused the financial crisis, much of these are now just being swapped for debt from the FHA, which has partly replaced these organizations as the source for subprime loans. In 2009 financial writer Shah Gilani predicted that this will cause it to eventually load taxpayers with $1 trillion in debt. Three years later those predictions have edged nearer to reality, as the FHA’s reserve fund has dipped well below the federally required 2%.

One reason for this has been the administration’s aforementioned failure to recognize changing preferences, reaffirming why bureaucracies like it are unsuited to deal in the free market. Leading into the recession, it continued subsidizing developments well outside of cities, many of which grew overnight and are now ghost towns; while ignoring condos that were reviving formerly vacant downtowns. It ignored them not only in spite of their frequent profitability, but also their obvious social goods, which are often more important to government entities anyway, but were overlooked here due to the sclerotic pace of reform.

The measures taken by the FHA in September to finally encourage condos may be a positive step—or it may not be, just propagating yet another real estate bust centered on unpredictable lifestyle whims. Hopefully either way, the administration can adjust these policies accordingly at the deadline, either by continuing to insure condos if they are in demand; or if they’re not, recognizing this, and sparing the public of more misdirected gambling. Perhaps even better, although unlikely, the FHA could just stop favoring certain housing styles, or income levels, altogether, so that a clearer view might emerge of what Americans actually want—and what specific homeowners can afford.


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