Accounting for FHA's Single-Family Mortgage Insurance Program on a Fair-Value Basis

May 18, 2011

Over the past two years, the Federal Housing Administration (FHA) has guaranteed more than 17 percent of new and refinanced mortgages on single-family homes in the United States. The estimated lifetime costs of FHAs single-family mortgage insurance program are recorded in the federal budget using a methodology spelled out in the Federal Credit Reform Act of 1990 (FCRA). Using the FCRA methodology, CBO estimates that the program will produce budgetary savings of $4.4 billion in fiscal year 2012.

However, FHAs mortgage guarantees still expose the government (and ultimately taxpayers) to potentially significant losses. This afternoon, CBO released an analysisprepared at the request of House Budget Committee Chairman Paul Ryanexamining the estimated cost of the program using a different accounting approach, fair-value estimating, which provides a more comprehensive measure of the cost to taxpayers of FHAs guarantees.

CBOs Findings

Fair-value estimates differ from estimates produced using the FCRA methodology in an important way: By incorporating a market-based risk premium, fair-value estimates recognize that the financial risk that the government assumes when issuing credit guarantees is more costly to taxpayers than FCRA-based estimates suggest. Using a fair-value approach, CBO estimates that the program will have a cost of $3.5 billion in 2012 on $233 billion in loan guarantees.

CBOs Analysis

Both the FCRA approach and the fair-value approach use an accrual basis of accounting, and they rely on the same projections of future cash flows. Both approaches take into account the lifetime cost of the new FHA loan guarantees made in a given year (including the expected costs of defaults and net of fees collected). But fair-value estimates differ in an important way from estimates produced using the FCRA methodology: They recognize that the governments assumption of financial risk has costs for taxpayers, and measure the cost of that risk by valuing liabilities, such as FHA loan guarantees, at the price the government would have to pay to induce a private-sector entity to assume those liabilities. In practice, the main difference between FCRA estimates and fair-value estimates is the effective discount rates used to calculate the present value of future guarantee costs and receipts: Whereas projected cash flows under FCRA are discounted using interest rates on Treasury securities, fair-value estimates are calculated using discount rates that incorporate a premium for market risk (that is, the type of risk that is reflected in market prices because investors require compensation to bear it).

The two approaches yield very different estimates of the impact of FHAs single-family mortgage insurance program on the federal budget: The effect of including an adjustment for the cost of risk would be to change the subsidy rate for FHAs single-family guarantee program from a negative rate of -1.9 percent under the FCRA methodology to a positive rate of 1.5 percent using a fair-value estimate. (A negative subsidy rate means that the present value of expected payments to the government for the loans guaranteed in 2012 exceeds the present value of expected payments from the government for those loans by an amount equal to 1.9 percent of the loan volume; a positive subsidy rate means the opposite.)

This analysis was prepared by Damien Moore.