Nearly one out of every four loans guaranteed by the U.S. Federal Housing Administration (FHA) would likely end in default over the next five years if another recession were to occur, according to a new measure of loan safety.
The new National Mortgage Risk Index (NMRI) for October indicates that 10.9 percent of mortgages backed by the federal government would go into default over the next five years if an economic crisis similar to 2008 were to occur. But that represents 23.2 percent of all FHA loans compared to just 5.6 percent of loans backed by mortgage giants Fannie Mae and Freddie Mac.
The new NMRI benchmark was developed primarily by Edward Pinto, a resident fellow at the American Enterprise Institute (AEI), and Stephen Oliner, a resident scholar at the conservative think tank. It was developed under the aegis of AEI’s new International Center on Housing Risk (ICHR).
Pinto, who has been a critic of the FHA, Fannie Mae, and Freddie Mac, said the NMRI is “a transparent and objective measure” of mortgage risk, home price risk, and the capital adequacy needed to evaluate and manage housing risk.
“The numbers aren’t conservative or liberal,” Pinto said. “How people use the numbers can be done through the lens of political orientation, but not the number themselves.”
The main index reportedly covers 85 percent of all new mortgages, while 100 percent of government-insured mortgages are covered.
During a media briefing, Pinto and Oliner, who are codirectors of the ICHR, said the index will help investors, lenders, policy makers, and even consumers assess and mitigate their mortgage and housing risks.
The recent financial crisis stemmed largely from the failure to understand the buildup of housing risk, they said, but better information can help dampen the boom/bust cycle and make corrections less damaging.
The authors said mortgages should be evaluated in the way cars are tested for their crashworthiness. They should be put to a stress test of a substantial drop in prices, Pinto said.
The index uses 1990-vintage loans as a benchmark––“a time when a preponderance of loans were considered safe”––as well as 2006–2007 vintages when lending standards were considered lax.
Measured against those standards, the index shows that fewer than half of all loans originated between August and October of 2013 can be considered low risk, which is defined as a default rate of less than 6 percent. More than 30 percent are high risk, defined as a default rate of 12 percent or more, and roughly 22 percent are medium risk.
FHA’s share of lower-risk mortgages, moreover, is less than 1 percent. And Fannie Mae’s share of higher-risk loans is growing, Pinto said. “Fannie Mae is adopting a higher-risk profile and taking business away from Freddie,” he said. “It is willing to accept riskier loans.”
The authors said that while the government has attempted to curb perceived risk factors, common-sense credit standards have yet to be adopted. And without such measures, they argued, the U.S. housing market will remain vulnerable to the gradual abandonment of sound underwriting standards.
The center also plans to introduce news indices of collateral risk and capital adequacy, and some two dozen international members are working on similar risk profiles for their own countries.
Working with Pinto and Oliner on the project are Morris Davis, academic director of the Graaskamp Center for Real Estate at the University of Wisconsin and a visiting AEI scholar, and economist Michael Molesky, a leading expert on mortgage default risk and insurance regulation.
