By Edward J. Pinto

Published: Monday, December 31, 2012, 9:01 p.m.
Updated: Tuesday, February 19, 2013

Imagine that a federal agency wanted to hurt America's working-class families on purpose. How would it inflict maximum damage?

It might start by aggressively marketing homeownership to marginal borrowers. It would tell them that bad credit scores aren't a problem. It would push them into homes they can't afford, saddle them with loans that barely build equity and provide no incentives for fiscal discipline. And when many of these homes go into foreclosure, it would leave families in financial ruin.

In short, such an agency would follow the Federal Housing Administration playbook.

That's a shame, because Republicans and Democrats alike rightly applaud the FHA's mission to provide responsible mortgage credit to low- and moderate-income Americans and first-time home buyers. But all too often, the FHA turns the American dream into a nightmare, setting up failure for the very families and neighborhoods its mission is to help.

This is not an isolated problem. A new study I completed at the American Enterprise Institute identified no fewer than 9,000 lower-income ZIP codes where the projected foreclosure rate on loans insured by the FHA in fiscal years 2009 and 2010 is more than 10 percent. Overall, one in seven families in these ZIP codes stands to lose their home and their savings. Many areas had failure rates of 20 percent, 30 percent and even higher.

Remember, these loans were written well after the housing collapse. Even in 2012, 40 percent of the FHA's loans are subprime — having a credit score below 660 or a debt-to-income ratio of 50 percent or more. When combined with minimal down payments and a 30-year term that builds equity slowly, the result is mortgage malpractice.

The FHA doesn't need to give up its mission. But it does need to acknowledge the harm its programs have caused.

First, end the practice of knowingly lending to people who cannot afford to repay their loans. The FHA uses its pricing advantages and lending policies to entice many low- and moderate-income families to take out irresponsible loans.

Second, help borrowers become owners, not debtors. The FHA nudges families onto a tightrope with no safety net, leaving them a broken water heater away from failure. Helping more borrowers take on 20-year, instead of 30-year, loans could cut their chance of losing a home 40 percent.

Third, concentrate on families that truly need help purchasing their first home. In recent years, the FHA has strayed far from its original mission, instead serving wealthier and wealthier home buyers as it quadrupled its insurance portfolio to $1.1 trillion. Since the FHA's mission is to help low- and moderate-income home buyers, the homes it finances should cost less than the area's median house price.

Fourth, step back from markets that can be better served by private lenders and insurers.

The same government mortgage complex that precipitated the crisis is still distorting the market. Pursuing the American dream starts with a reality check. When Americans are given honest information about prices and risks, we make smart choices. But when the government tries to convince us that price and risk don't apply, hope turns to hopelessness.

Edward J. Pinto, an executive vice president and chief credit officer for Fannie Mae in the 1980s, is a resident fellow at the American Enterprise Institute.

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