Thank you all for attending this hearing examining FHA's role in the mortgage insurance market. This is the third in a series of hearings on FHA -- and in my opinion the most important hearing to truly understand FHA's business model.
In our previous hearings, we learned that FHA is nearing insolvency, putting taxpayers at risk of another government bailout. We learned that FHA is operating far outside its historical mission, which is hindering the development of a sustainable housing finance market. And finally, we learned that members on both sides of the aisle strongly support FHA's core mission of providing access to credit for lower-income borrowers and first-time homebuyers.
Today's hearing will explore the business model of mortgage insurance and analyze some of the advantage FHA has relative to private mortgage insurers that compete for the same business.
When we view FHA from a policy perspective, we have to remember that FHA is in the business of insurance. But we will find out today that FHA runs its MMI Fund contrary to the most basic principles of insurance. FHA does not evaluate its risk according to actuarial principles; it does not correlate premiums to risk; it does not spread its risk in a manner supported by its financial resources; and it relies on treating poor results as a quarantined anomaly.
With regard to solvency -- which is the cornerstone of insurance regulation -- FHA misses the mark by a long shot. FHA's most recent actuarial report showed that its MMI Fund capital reserve ratio, which is a major benchmark for solvency, fell to negative 1.44% - well below the Congressional mandated minimum of 2 percent. While private mortgage insurers are instructed to halt all new business once capital reserve ratios fall below 4%, FHA has continued to expand business despite being vastly undercapitalized.
FHA shares other advantages relative to its competitors in the private market. On pricing, private insurers use actuarially sound pricing that must include overhead expenses; FHA uses artificially low, uniform pricing that excludes administrative and technological costs. On reserving for losses, private insurers follow 4 different reserve requirements; FHA does not set aside reserves. On accounting, private insurers use GAAP accounting; FHA masks its true financial health with government accounting. And on risk transfer, private insurers oftentimes pay to cede risk to the reinsurance market; FHA has a limitless backstop from the U.S. Treasury.
All of these advantages result in a much lower cost of capital for FHA relative to private insurers. This wouldn't necessarily be a problem if FHA stuck to its historical mission and narrowly targeted its subsidies to lower-income individuals. But, as FHA has attempted to grow out of its past underwriting mistakes, it has expanded its subsidies to large areas of the housing finance market- including high-income borrowers - that do not need government subsidies. Consequently, FHA is directly competing with the private mortgage insurance market on a playing field that is anything but fair.
Not surprisingly, FHA's unwieldy growth has crowded out private capital in the mortgage insurance space and has left private insurers struggling to raise new capital. According to the GAO, FHA's share of the mortgage insurance market, based on volume of loans, stands at 56% compared to just 19% for the private insurers.
There is a proper role for FHA in the housing finance market, but I believe it should be a complement to the private market, not a direct competitor. I look forward to working with Ranking Member Capuano to address these important issues in the months ahead.