Mortgage Financing:

FHA's Fund Has Grown, but Options for Drawing on the Fund Have Uncertain Outcomes

GAO-01-460: Published: Feb 28, 2001. Publicly Released: Mar 19, 2001.

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The Mutual Mortgage Insurance Fund has maintained an economic value of at least two percent of the Fund's insurance-in-force, as required by law. GAO's and the Department of Housing and Urban Development's (HUD) analysis show that the Fund had an economic value of $15.8 billion (3.20 percent) and $16.6 billion (3.66 percent), respectively. Given the economic value of the Fund and the state of the economy at the end of fiscal year 1999, a two-percent capital ratio appears sufficient to withstand moderately severe economic downturns that could lead to worse-than-expected loan performance. However, under more severe economic conditions, the economic value of two percent of insurance-in-force would not be adequate. Because of the uncertainty and professional judgment associated with this type of economic analysis, GAO cautions against relying on one estimate or even a group of estimates to determine the adequacy of the Fund's reserves over the longer term. HUD could exercise several options under current legislative authority to reduce the capital ratio for the Fund. It is difficult, however, to reliably measure the impact of policy changes on the Fund's capital ratio and Federal Housing Administration borrowers without using tools designed to estimate the multiple impacts that policy changes often have. Nonetheless, any option that reduces the Fund's reserve, if not accompanied by a similar reduction in other government spending, would result in a budget surplus reduction or a deficit increase.

Matter for Congressional Consideration

  1. Status: Closed - Implemented

    Comments: Legislation based on this recommendation was introduced in the 107th Congress in HR 3995 Sec 226. The legislation would have required a minimum adequate capital level by requiring HUD's Secretary to ensure that, at all times, the Mutual Mortgage Insurance Fund maintains capital in an amount equal to or greater than the minimum adequate capital level. The minimum level was defined as the amount equal to the sum of the minimum basic capital ratio and the minimum risk-based capital ratio. HR 3995 section 226 defined these terms as follow. The minimum basic capital ratio is the amount that is equal to one percent of the unamortized insurance-in-force. The minimum risk-based capital ratio is the amount that would permit the Mutual Mortgage Insurance Fund to withstand mortgage defaults and prepayments associated with a broad range of adverse economic circumstances, which shall include: (1) circumstances derived from historical regional and national experience in which mortgages insured under this Act experienced high rates of default and prepayment; (2) events that may plausibly occur in the future, notwithstanding that such events may not have occurred in the past, and which could result in high rates of mortgage defaults or prepayments or both; and (3) circumstances under which multiple such events occur simultaneously or in rapid succession. This legislation was not passed.

    Matter: Congress may want to consider taking action to amend the laws governing the Fund to specify criteria for determining when the Fund is actuarially sound. Because GAO believes that actuarial soundness depends on a variety of factors that could vary over time, setting a minimum or target capital ratio will not guarantee that the Fund will be actuarially sound over time. For example, if the Fund were comprised primarily of seasoned loans with known characteristics, a capital ratio below the current 2-percent minimum might be adequate, but under conditions such as those that prevail today, when the Fund is comprised of many new loans, a 2-percent ratio might be inadequate if recent and future loans perform considerably worse than expected. Thus, Congress may want to consider defining the types of economic conditions under which the Fund would be expected to meet its commitments without borrowing from the Treasury.

Recommendations for Executive Action

  1. Status: Closed - Not Implemented

    Comments: HUD has not implemented this recommendation but in 2010 took initial steps toward adopting a methodology, known as stochastic simulation, to better incorporate the variability of economic variables into estimates of the Fund's capital ratio.

    Recommendation: If Congress decides that no further guidance is necessary, to better evaluate the health of the Fund and determine the appropriate types and timing of policy changes, HUD should develop criteria for measuring the actuarial soundness of the Mutual Mortgage Insurance Fund. These criteria should specify the economic conditions that the Fund would be expected to withstand and may specify capital ratios currently consistent with those criteria.

    Agency Affected: Department of Housing and Urban Development

  2. Status: Closed - Implemented

    Comments: In the actuarial reviews for 2001 through 2003, HUD's actuarial review contractor estimated the Fund's capital ratio using additional stress scenarios that the contractor indicated were based on scenarios from our report (GAO-01-460). Additionally, the reviews for 2004 through 2009 included stress scenarios assuming house price declines over the subsequent 3 years. Further, the 2004 through 2007 reviews contained scenarios that considered multiple stress events, including low house price appreciation combined with higher interest rates.

    Recommendation: Because many conditions affect the adequacy of a given capital ratio, the independent annual actuarial analysis should give more attention to tests of the Fund's ability to withstand appropriate stresses. These tests should include more severe scenarios that capture worse-than-expected loan performance that may be due to economic conditions and other factors, such as changes in policy and the conventional mortgage market.

    Agency Affected: Department of Housing and Urban Development

  3. Status: Closed - Implemented

    Comments: Over the past several years, FHA has improved its analytical tools for assessing the impact of policy changes on the volume and riskiness of the loans it insures. For example, in formulating a 2006 risk-based pricing proposal, FHA developed performance metrics by FICO score and loan-to-value (LTV) ratio and has used these metrics to estimate claim and prepayment rates for different FICO-LTV combinations. FHA also developed a spreadsheet to estimate volume expectations based on forecasts of market activity and historical information on patterns in FHA's market share at different stages of the economic cycle.

    Recommendation: To more fully assess the impact of policy changes that are likely to permanently affect the profitability of certain Federal Housing Administration (FHA)-insured loans, the Secretary of Housing and Urban Development should develop better tools for assessing the impact these changes may have on the volume and riskiness of loans that FHA insures. Such analysis is particularly important where the policy change permanently affects certain loans, as in the case of underwriting and premium changes. Without a better analytical framework to assess the full impact of policy changes that permanently affect certain loans, such changes should be made in small increments so that their impact can be monitored and adjustments can be made over time.

    Agency Affected: Department of Housing and Urban Development


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