AEI: Federal Housing Administration at financial risk

The American Enterprise Institute worries that the Federal Housing Administration could be headed for financial trouble:

Concerns are rising that the Federal Housing Administration could run out [of] money if the economy doesn't recover soon, raising the risk the agency would seek a taxpayer bailout for the first time in its 77-year history.

Since the mortgage crisis erupted five years ago, the FHA has played a critical role in housing finance as private lenders retreated. It backs about a third of all new mortgages originated for home purchases, up from around 5% in 2006.

But, as the FHA prepares to release its annual financial report next week, a forthcoming study by Joseph Gyourko, a real estate and finance professor at the University of Pennsylvania's Wharton School, estimates that the FHA faces around $50 billion in losses in the coming years.

The study says only a "quick and substantial economic and housing market recovery" can avoid "substantial losses for American taxpayers." The paper was commissioned by the American Enterprise Institute, a conservative think tank.

The study says the losses will be spread over a period of many years and are unlikely to bankrupt the agency this year or next.

The study isn't the first to predict the FHA's insolvency.

While reports from partisan think tanks should always be taken with a grain of salt, I have long worried that the federal government's attempts to prop up housing prices could be causing it to under-price the risk of government-insured loans.

The theory is simple: In the first half of the last decade, midsize banks like Countrywide Financial, Washington Mutual, and IndyMac supported a bubble by making bad mortgage loans. After the bubble burst and the financial crisis began, the federal government stepped in to prop up housing prices by... making bad mortgage loans.