Higher Downpayment for FHA Loans?

In a moment of apparent sanity by our elected officials, Congressman Scott Garrett (Rep-NJ) proposed a bill today that would raise the FHA’s minimum downpayment from 3.5% to a whopping 5%. The bill would also eliminate FHA financing of closing costs (apparently the legal and title fees are too much for many homebuyers to shoulder).

While hardly a meaningful deterrent from the speculative lending helping to inflate the housing market, the bill suggests to me that at least some legislators are waking up to the disaster that is the FHA. It will be interesting to see if the bill gets passed, though the pessimist in me says that the majority of folks in Congress will not want to do anything to disrupt the “nascent recovery” in housing.

The market has been due for a correction for a multitude of reasons, not least of which is a 60% run off the bottom. However, anything that results in a tightening of mortgage credit (i.e. higher downpayments for FHA loans, allowing the $8,000 new home buyer tax credit to elapse) or represents a lessoning of the government’s influence in the overall economy remains the most critical factors to monitor as investors gauge the sustainability of this liquidity driven rally.

For those who haven’t read it yet, I would definitely take a read of Fed Governor Kevin Warsh’s op-ed piece in last week’s Wall Street Journal (“The Fed’s Job Is Only Half Over”). While Warsh generally tows the party line that the economy remains very fragile and the Fed will likely need to maintain its accommodative stance for some time, he does suggest that the Fed should begin to plan its exit policy. While very subtle, it is the first time I have distinctly heard one of the Governors hint at a potential tightening by the Fed.

You be the judge based on these three paragraphs:

Today, even more than usual, we should maintain considerable humility about optimal policy. Financial market developments bear especially careful watching. They may impart more forward-looking signs of growth and inflation prospects than arithmetic readings of stimulus-induced gross domestic product or lagged composite readings of inflation. For example, the level of asset prices and associated risk premiums, and gauging their trend and durability, will demand careful assessment.

In this environment, market participants and policy makers alike should steer clear of ironclad policy prescriptions. Nonetheless, I would hazard the view that prudent risk management indicates that policy likely will need to begin normalization before it is obvious that it is necessary, possibly with greater force than is customary, and taking proper account of the policies being instituted by other authorities.

"Whatever it takes" is said by some to be the maxim that marked the battle of the last year. But, it cannot be an asymmetric mantra, trotted out only during times of deep economic and financial distress, and discarded when the cycle turns. If "whatever it takes" was appropriate to arrest the panic, the refrain might turn out to be equally necessary at a stage during the recovery to ensure the Federal Reserve's institutional credibility. The asymmetric application of policy ultimately could cause the innovative policy approaches introduced in the past couple of years to lose their standing as valuable additions in the arsenal of central bankers.