Case Study: FHA's Default Insurance Program Had Still Has Strategically Provides for or Creates Public Value

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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,… [END OF PREVIEW]

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