Inflation Pressures Are Easing but Rate Cut Forecast Remains Uncertain

The New Year is beginning where the old one ended -- with uncertainty about when – or whether – the Federal Reserve will begin cutting interest rates.

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Struggling to bolster reserves depleted by loan losses that are threatening the solvency of its insurance fund, the Federal Housing Administration (FHA) is increasing premiums on the low-down-payment home mortgages the agency insures. The increase, equaling one tenth of one percent of the loan amount, is the second the agency has implemented this year in an effort to avoid what would be the first taxpayer bailout in its 78-year history.

In February, FHA officials increased premiums by 75 basis points (from 1 percent to 1.75 percent) and tightened underwriting requirements for a broad range of loans, in an effort to stabilize the mortgage insurance program’s wobbly finances. But the agency’s annual audit indicates those measures have fallen short. According to that report, issued just before Thanksgiving, the insurance fund is facing an anticipated deficit of $16.3 billion this year, based on current projections for loan losses and premium income.

Most of the losses are linked to loans originated during the housing crisis, as the FHA has stepped up in a big way to fill the gap created by the dearth of private sector mortgage financing. That activity nearly tripled the agency’s loan portfolio, increasing its liabilities and straining its insurance fund. The agency now insures nearly one third of all residential mortgages compared with only about 5 percent in 2006.

“With its dual mission of providing access to homeownership for underserved populations and supporting the housing market during tough times, there’s little doubt that FHA helped prevent a much deeper crisis,” Shaun Donovan, Secretary of the Department of Housing and Urban Development, observed recently. “That progress, however, has not been without stress,” he acknowledged.

The FHA’s cash reserves plummeted to a record low of $2.6 billion last year (insuring a portfolio of about $1.1 trillion in loans), triggering warnings that taxpayer assistance was inevitable. The audit report has renewed those warnings.

“A substantial portion of their loans continues to be high risk,” Edward Pinto, a former Fannie Mae executive, now a resident fellow at the American Institute, a conservative think tank, told Reuters. “While they’ve been trying to dig themselves out of this hole, to some extent, the hole has gotten deeper.”

FHA officials say the audit’s findings are based on overly conservative projections for loan losses and home prices that do not reflect improving conditions in the housing market. A separate report by the Mortgage Bankers Association, found that delinquencies on government-backed loans declined in the third quarter. Ironically, the agency has also been victimized somewhat by the housing recovery, because borrowers have taken advantage of record low interest rates to refinance their loans, eliminating FHA insurance and reducing the agency’s premium income.

The latest round of premium hikes may also be something of a double-edged sword, strengthening the insurance fund, but also making it more difficult for the agency to fulfill its primary mission provide affordable mortgages for lower income borrowers.

“It’s a tightrope,” Carol Galante, the acting FHA commissioner, told the Washington Post, adding, “We continue to look at that balance every day.”


Federal regulators have been scrutinizing ads for residential mortgages, and they don’t like what they’ve seen. The Consumer Financial Protection Bureau (CFPB) and the Federal Trade Commission (FTC) have announced a joint effort to reign in the “misleading” advertising they found in a coordinated review (agency officials described it as a “sweep”) of approximately 800 mortgage-related ads produced by non-bank entities.

The agencies have sent letters to a combined total of 32 of these companies, warning them that they may be violating regulations prohibiting misleading claims in mortgage ads. The letters cited untrue claims about government affiliations, misleading information about interest rates and unfounded promises about speedy approvals, among other concerns.

The CFPB is formally investigating six companies and the FTC is investigating 6, according to press reports.

"Baiting consumers with false ads to buy into mortgage products would be illegal. We will conduct a fair and rigorous investigation into these issues and will take appropriate action for any violations we find," CFPB Director Richard Cordray said in a press release. The agency is particularly concerned about ads targeting older Americans and military veterans, he noted.

Mortgage advertising has declined during the downturn, Thomas Paul, an assistant director at the FTC, acknowledged during a conference call with reporters. But it is likely, he said, that the volume will increase as the housing market recovers. “One of the things we wanted to do through conducting this sweep,” he explained, “was to [ensure] that when mortgage advertisers start disseminating claims again, that they are aware of their obligation to make sure that none of those ads contained deceptive claims."


As the economy improves, many of the young adults (and older ones) who moved in with their parents – or never left home – are finding jobs and housing of their own, ‘unbundling” many of the households that were bundled during the downturn. But household formation rates remain well below historical norms, suggesting that large segment of what should be the new household cohort hasn’t gotten there yet.

Mark Zandi, chief economist at Moody’s Analytics, has calculated that there are nearly 2 million fewer households today than would be the case in a “normal” economy. The difference, he says, is largely in the 18-34 age group – ‘echo-boomers’ who are still living with their parents or doubling up with friends. Zandi estimates that more than 17 million adult children were living with their parents this year, up from 15.3 million five years ago, before the economy cratered.

Nearly 20 percent of these ‘home again’ or ‘still at home’ adult children were unemployed in March of last year, according to a recent U.S. Census Bureau report. That report also indicates that the number shared households increased by 11.4 percent between 2007 and 2011, while new household formations increased by only 1.3 percent. In the depth of the recession (between January, 20008 and January 2011, the household formation rate fell to its lowest level since 1970, when the Census Bureau began tracking that data.

But analysts see an improving trend. New household formations rebounded strongly in 2010 and 2011, growing by 1.3 million and 1.7 million, respectively, in those years, “tilt[ing] the trailing average back in the right direction,” economists at American Century Investments note in a recent blog. “This represents an important trend, especially when viewed in the context of recent gains in home prices and sales,” they suggest.

That upward trend is likely to continue, adding 1.3 million households annually for the rest of this decade, they predict, suggesting that housing demand “may explode as the economy emerges from the worst housing crisis since 1937. And, with housing inventory currently at a 30-year low,” the American Century economists expect, any significant surge in demand could exceed existing supply, creating the potential for housing to once again contribute more meaningfully to economic growth.”


Reflecting a modest but noticeable easing of underwriting requirements, homebuyers are making (and lenders, presumably, are accepting) smaller down payments. The median for all homebuyers this in 2012 was 9 percent – much higher than during the housing boom (when no-down-payment loans were common), but the lowest average since 2009, according to data compiled by the National Association of Realtors (NAR). More than 40 percent of first-time buyers used the no-down-payment option in 2007, the NAR reported; the median down payment for that year was only about 2 percent.

Four years later, reeling from out-sized losses during the housing collapse, lenders tightened their qualifying standards and the median down payment jumped to 11 percent. The NAR analysis also found that:

  • More than three-quarters of first-time buyers financed their down payments partly or completely from savings.
  • 24 percent received financial help from relatives (primarily their parents), and 6 percent tapped retirement accounts.
  • The vast majority (93 percent) of first-time buyers selected fixed-rate mortgages.
  • Nearly half (46 percent) obtained FHA loans and 10 percent obtained VA loans, which do not require a down payment.

Lenders who are easing their requirements are doing so at least in part because the economy has improved and the applicants they are seeing are in better shape than they were a few years ago. Median credit scores have increased by 40 points since 2006, rising to their highest level in more than a decade, the economists at the Federal Reserve Bank of Atlanta reported recently. Borrowers have also become more realistic – or more honest – about the income they report on mortgage applications.

“Comparing home-purchase borrower incomes reported in the HDMA data with income reported by homebuyers in household surveys suggests that incomes on mortgage applications were likely significantly overstated during the peak of the housing boom," the Fed researchers concluded.


The state attorneys general who negotiated a multi-million-dollar settlement with mortgage lenders and servicers accused of foreclosure-related abuses are urging Congress to extend the Mortgage Debt Relief Act of 2007.

If that legislation expires, as scheduled, at the end of this year, troubled borrowers who receive loan modifications will owe taxes on the forgiven debt, “making the National Mortgage Settlement much less effective,” the attorneys general warn in a letter to House and Senate leaders. The five largest banks covered by the settlement – Bank of America, JP Morgan, Chase, Wells Fargo, Ally Financial and Citigroup, have provided a combined total of more than $26 billion in relief to borrowers thus far, according to a recent report.

“Failure to extend this tax exclusion will result in $1.3 billion in tax increases on the very families who can least afford it,” the letter, signed by 41 attorneys general, notes. “Each of our offices receives calls every day from homeowners trying to save their homes or struggling to recover from losing their homes,” the letter continues, adding, “a home lost to foreclosure depresses future home sale prices, damages the value of surrounding homes, and harms families, neighborhoods and our general economy.”