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The Orange County Register - Scott Garrett: Accounting Tricks Hide FHA Insurance Risk


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The great political economist Frédéric Bastiat aptly observed, "People are beginning to realize that the apparatus of government is costly. But what they do not know is that the burden falls inevitably on them." To look at it another way, there is no such thing as a free lunch when it comes to government programs. The costs are always borne by the American people. The facts indicate that, not only is government costly, but also it costs more than initially expected. Simply put, the burden of government rarely comes in under budget.

Nowhere does this ring truer than with Federal Housing Administration mortgage insurance. As the largest mortgage insurer in the world, the FHA provides protection to private lenders against the possibility of a borrower's default. Because of the government's promise to make lenders 100 percent whole in the event of foreclosure, FHA-backed mortgages typically require smaller down payments and are available to borrowers with riskier credit.

The FHA's Mutual Mortgage Insurance Fund -- the largest of FHA's mortgage insurance programs that covers single-family homes -- is insolvent and yet is backed by the full faith and credit of the United States. It may come as a surprise to many taxpayers that the MMIF benefits from a direct, automatic, and unlimited line of credit from the Treasury. In other words, a bailout would not require congressional action. As a result of the housing market collapse, the economic downturn and increased mortgage defaults, the MMIF's finances are in very dire straits, making a bailout increasingly likely.

One telling measure of the MMIF's financial health is its capital reserve. By law, the capital reserve must be at least 2 percent of the insurance portfolio. Last November, the Department of Housing and Urban Development released the latest annual report on the MMIF's financial position. It was all bad news. The fund's economic value totaled negative $16.3 billion against a commitment of $1.13 trillion in insured mortgages. of insurance-in-force. This amounts to a capital reserve of negative 1.4 percent, hardly a picture of health and solvency.

The typical narrative of a government-program-gone-bankrupt should come as no surprise. However, it defies common sense that the MMIF -- according to the administration's federal accounting rules -- actually makes money for the government. Only through the alchemy of government accounting can you transform a mortgage portfolio of figurative lead into gold and still remain true to the law.

This free money comes courtesy of the Federal Credit Reform Act of 1990. Under FCRA's cooked accounting rules, the cost of federal mortgage insurance is determined on the basis of subsidy cost, including the risk that the borrower defaults on his mortgage. The subsidy cost represents, in present-value terms, the amount the loans are expected to earn or lose over the course of their lives. FCRA uses the interest rate on Treasury securities to calculate subsidy cost.

Therein lies the rub. By using the Treasury rate, FCRA does not account for market risk, or overall systemic risk. Unlike fair-value accounting -- which appropriately incorporates a premium for market risk -- FCRA fails to reflect the true cost to the taxpayer of FHA-backed mortgage insurance.

For example, in a 2011 report, the nonpartisan Congressional Budget Office (CBO) compared the cost of FHA single-family mortgage insurance on both a FCRA and fair-value basis. CBO estimated that, under FCRA accounting, FHA would raise $4.4 billion for the federal government in 2012. On a fair-value basis, with an appropriate accounting of market risk, CBO estimated that FHA would lose $3.5 billion over the same period. As Bastiat rightly observed, the governmental apparatus does not come cheap.

Because CBO believes that fair value provides a fuller picture of a program's budgetary impact, it now employs fair-value accounting as standard procedure for federal loan and loan guarantee programs such as FHA. However, the Obama administration has strongly resisted the move to fair-value accounting, and instead, clings to the dangerous fiction of FCRA and accounting alchemy.

To bring a ray of sunshine to federal budgeting, last Congress, the House passed a bill that I authored -- the Budget and Accounting Transparency Act. This legislation would require that the administration follow CBO's example and account for federal loan and loan guarantee programs on a fair-value basis. While this bill never made it to the president's desk for signature, I am hopeful that the administration will wake up to an unfortunate economic reality: much like the FHA, free lunches end up costing a lot more than we expect. It's not fair to keep putting the American people on the hook.

Rep. Scott Garrett represents New Jersey's Fifth Congressional District. He is a senior Member of the House Budget Committee and Chairman of the Financial Services Subcommittee on Capital Market and Government-Sponsored Enterprises.

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