CONGRESS OF THE UNITED STATES

CONGRESSIONAL BUDGET OFFICE

A

PAPER

NOVEMBER 2003

Subsidy Estimates 

for FHA Mortgage

Guarantees

CBO

CBO

A

P A P E R

Subsidy Estimates for

FHA Mortgage Guarantees

November 2003

The Congress of the United States O Congressional Budget Office 
Note

Numbers in the text and tables of this report may not sum to totals because of rounding.
Preface

Federal Housing Administration (FHA) guarantees of home mortgages account for more

than half of all federally insured loans, and net budgetary collections from that program are

expected to offset about half of the cost of all other federal loan guarantees. Actual net receipts for FHA, however, have fallen short of expectations for the past decade. That discrepancy between projected and realized cash inflows has raised doubts about the reliability of

budget estimates for the program.

This Congressional Budget Office (CBO) analysis of FHA’s subsidy estimates is one part of

a response to a request from the House Budget Committee to review the budgetary treatment of federal credit programs and possible improvements in and extensions of current

practice. The paper draws on research begun in response to a request from the House Committee on Banking and Financial Services. Consistent with CBO’s mandate to provide objective, impartial analysis, this paper makes no recommendations. 

 

Using a model developed by Charles A. Capone Jr., formerly of CBO, the staff of CBO’s

Microeconomic and Financial Studies Division prepared this report under the direction of

Marvin Phaup and Roger Hitchner. Many others at CBO contributed to the model, including Bob Arnold, Ufuk Demiroglu, Robert Dennis, Deborah Lucas, and John Peterson. The

sub-model for regional house-price movements was developed by Malgorzata Klosek. 

Research assistance and computer programming support were provided by Jenny Au, Sean

Corcoran, Lori Ellebracht, Carol Frost, Erin Hirsch, Joseph Nichols, DaRon Ross, and

Errick Simmons. Information technology support was provided by Georgia Brown, Eric

Guille, Guanli Lu, and Rick Williams. The report also benefited from comments by CBO

analysts Perry Beider, Kim Cawley, Sunita D’Monte, Cary Elliot, Peter Fontaine, Mark

Hadley, Susanne Mehlman, Albert Metz, Mark Musell, Elizabeth Robinson, and David

Torregrosa.

CBO is grateful to FHA for providing access to the data required for this study and to Judy

May, Dominic Stasulli, and Ed Szymanoski of FHA for their help. Many other staff members at FHA and the Department of Housing and Urban Development were also helpful,

including Harold Bunce, Darryl Getter, Ian Keith, and Maude Williams. 

Christine Bogusz edited the report, and Christian Spoor proofread it. Maureen Costantino

designed the cover, and Sharon Corbin-Jallow prepared the paper for publication. Lenny
iv SUBSIDY ESTIMATES FOR FHA MORTGAGE GUARANTEES

Skutnik produced the printed copies, and Annette Kalicki prepared the electronic versions

for CBO’s Web site (www.cbo.gov).

Douglas Holtz-Eakin

Director

November 2003
Contents

Summary vii

Introduction 1

FHA in the Budget 1

Estimating FHA Subsidies 2

Indications of Upward Bias in Estimates of Net Collections 2

Reestimates 2

Current Estimating Method 3

Incorporating Volatility and Multiple Economic Paths 4

Estimates for the 2003 Cohort 5

Implications 7
vi SUBSIDY ESTIMATES FOR FHA MORTGAGE GUARANTEES

Tables

1. Original and Reestimated FHA Subsidy Rates, by Cohort,

1992 to 2002 3

2. Original and Mean-Value FHA Subsidy Rates, by Cohort,

1992 to 2002 4

3.

1992 to 2002 5

4. Projected Total FHA Reestimates, by Cohort, 1992 to 2002 7

Figure

1. Frequency Distribution of FHA Subsidy Rates for the

2003 Cohort 6

Original and Mean-Value FHA Subsidy Estimates, by Cohort,
Summary

The Federal Housing Administration (FHA)

guarantees home mortgages for eligible home buyers.

By protecting lenders against credit losses when borrowers default, FHA increases the availability of mortgage loans, especially for borrowers with few financial

resources or short credit histories. In connection with

that service, FHA collects guarantee fees paid by borrowers.

FHA home loan guarantees are unusual among federal

credit programs in that they are generally estimated to

produce net income for the government, rather than

net costs. That is, the value of collections from guarantee fees is expected to exceed the value of outlays

from defaults. The projected gain to the government

from those guarantees during the 1992-2002 period

was about 2.5 percent of the dollar volume of loans

guaranteed. Actual program performance, however,

has fallen short of expectations. Credit subsidy reestimates for guaranteed mortgages disbursed during that

period reduced the expected gain to the government

by about 0.5 percent of the total dollar volume. On

nearly $900 billion in guaranteed loans, that downward revision amounts to more than $4 billion in 

anticipated net collections that are no longer expected.

A plausible explanation for the tendency of FHA’s

budget estimates to overstate expected gains is the use

of a single, smooth economic forecast to project cash

flows from loan guarantees. The actual path of the

economy is not smooth; rather, it exhibits fluctuations

in interest rates, housing prices, income, and unemployment, among other variables. Mortgage loan 

defaults, which trigger payments by FHA, and loan

prepayments, which halt the inflow of annual FHA

guarantee fees, are sensitive to economic changes, especially to variations in housing prices and mortgage

interest rates. Accordingly, FHA’s outlays and receipts

are themselves sensitive to such movements. By failing

to account for economic fluctuations, FHA’s current

method of forecasting its cash flows from mortgage

insurance may tend to underestimate both defaults

and prepayments and, therefore, to overestimate net 

income to the government from mortgage insurance.

One solution, developed by the Congressional Budget

Office (CBO) and described in this report, is to incorporate into the forecast the observed historical volatility of key economic variables. That can be done by

simulating multiple paths for the economy that start

from current conditions and follow CBO’s baseline

forecast but also exhibit historical variation in economic activity, prices, and interest rates. A volatile

forecast path, along with estimates of the effects of

those economic variables on loan defaults and prepayments, could be used by FHA to project cash flows

more accurately. Cash flows could then be converted

into expected net collections or subsidies to FHA.

CBO’s approach calculates net income for a large

number of different, but possible, economic paths.

The average of net income from all those paths is an

estimate of net cash inflows that is free of the upward

bias introduced by using a single, smooth path.

CBO’s approach would reduce the value of expected

net receipts from FHA-guaranteed loans by including

economic volatility in the forecast, by using a model

of defaults and prepayments estimated from historical

data, and by averaging FHA’s net receipts across 1,000

alternative economic paths. Using that approach for

mortgages disbursed between 1992 and 2002 would

have lowered projected net collections from about $22
viii SUBSIDY ESTIMATES FOR FHA MORTGAGE GUARANTEES

billion (an average of $2 billion for the guaranteed

loans disbursed in each budget year, or cohort) to

about $12 billion ($1.1 billion per cohort). 

Budgetary receipts from FHA loan guarantees made

between 1992 and 2002 have already been subject to a

series of downward adjustments totaling $4 billion (to

a current level of $18 billion) on the basis of experience to date. The method described here for incorporating economic volatility into estimates of net collections suggests that FHA’s initial estimates for singlefamily home mortgages may have been overstated for

all cohorts guaranteed during the 1992-2002 period

by as much as $9.6 billion. The accuracy of the new

estimates will be tested by future reestimates before the

loans guaranteed during that period mature.
Subsidy Estimates for FHA

Mortgage Guarantees

Introduction

The Federal Housing Administration provides a federal guarantee of mortgage loans funded through private lenders and state and local housing finance agencies. Since its inception in 1934, FHA has become an

important contributor to home financing for firsttime and low-income home buyers.1

At the start of the 2003 budget year, FHA’s portfolio

of loan guarantees was $563.4 billion, of which

$467.3 billion (83 percent) was for single-family

mortgages that are accounted for in the Mutual Mortgage Insurance Fund (MMIF). Programs operating

through that fund are expected to be self-supporting.

They are the focus of this analysis. 

The Secretary of the Department of Housing and Urban Development has a statutory obligation to balance

the financial soundness of MMIF programs with the

housing finance demands of first-time home buyers

and buyers with low down payments.2

 In addition, the

Secretary has authority to adjust the insurance premiums charged to insured borrowers as necessary to try

to meet those competing goals. The Secretary, however, must charge all borrowers the same premium

without regard to differences in individual risk.

FHA in the Budget

The budgetary treatment of FHA loan guarantees follows the provisions of the Federal Credit Reform Act

of 1990, which became effective with the 1992 budget

year. Under credit reform procedures, the cost of federal credit activity in a budget year is the net present

value of all expected future cash flows from guarantees

and direct loans disbursed in that year. For loan guarantees, cash inflows consist primarily of fees charged

to insured borrowers, and cash outlays consist mostly

of payments to lenders to cover the cost of loan defaults. To calculate the net present value of activity for

a budget year (a loan or guarantee cohort), FHA must

forecast annual cash flows for the life of the mortgages

it guarantees. Projected future cash flows are then discounted to the year in which the guaranteed loan was

disbursed using interest rates on Treasury securities

whose maturities match those of the cash flows. The

discounted loss (or gain) is the estimated budgetary

cost or subsidy value of the cohort of loans issued in

the budget year. 

The net value of each cohort’s cash flows is often expressed as a percentage of the volume of guaranteed

loans in the cohort—that is, as a subsidy rate. Perdollar subsidy rates are especially convenient for comparing costs across cohorts of various sizes and across

programs whose terms may differ. To prepare the

budget, estimated subsidy rates are multiplied by the

projected or authorized loan volume to arrive at estimates of the dollar amount of subsidies expected to be

obligated or committed by each credit program.

Under current estimating procedures, the discounted

present value of expected fee income from FHA’s loan

guarantees—taking account of expected prepayments

—exceeds the discounted present value of expected

1. FHA does not insure so-called subprime loans (those to borrowers with tarnished credit ratings), but the President’s budget for 2004 proposes to extend FHA’s guarantee authority to

such mortgages. That proposal is included in the Senate version of the 2004 appropriations bill for the Departments of

Veterans Affairs and Housing and Urban Development.

2. See 12 U.S.C. 1711(h)(2).
2 SUBSIDY ESTIMATES FOR FHA MORTGAGE GUARANTEES

default expenses. Thus, under current budgetary procedures, FHA is expected to produce an inflow of net

budgetary resources from its loan guarantee activity.

Credit programs that produce net income rather than

net outlays are said to have “negative subsidies” and

“negative subsidy rates,” because net income from

business-type activities is shown in the budget as negative outlays. When actual cash flows differ from original budget estimates, subsidy rates are “reestimated” to

incorporate that information into the budget.3

Estimating FHA Subsidies

The subsidy estimate for each cohort is calculated on

the basis of the contract terms of the loan guarantee

and the economic forecast used to project future loan

terminations from prepayments and defaults. Contract

terms for FHA include the fees charged to borrowers

and the default-related expenses of lenders that FHA

will reimburse. Borrowers now pay a fee of 1.5 percent

of the loan amount at origination and monthly fees

that sum to an annual rate of 0.5 percent of the outstanding loan balance. The fee at origination is included in the loan amount, which enables borrowers

to pay the fees for FHA insurance through their

monthly mortgage payment.

FHA’s default-related expenses come primarily from

foreclosures on mortgaged properties to satisfy unpaid

debts. After a lender completes a property foreclosure,

FHA pays off the balance of the defaulted mortgage; it

also reimburses lenders for two-thirds of foreclosurerelated expenses and for mortgage interest income not

received from the borrower during the default period.4

Once FHA pays the lender the insurance claim, it

takes possession of the property, which leads to a series

of cash flows for property management and sales expenses, along with revenue from the final sale of the

property.

The economic forecast used to project FHA’s cash

flows includes future interest rates and housing prices.

Those variables affect the rates at which loans are expected to be prepaid or to default during the life of the

guaranteed loans—up to 30 years. When loans are

prepaid, fee income to FHA stops. Also, if borrowers

prepay their loans in full during the first five years,

FHA refunds a portion of the premium paid at loan

origination. When loans terminate through default,

fee income also stops and foreclosure expenses are incurred. So whether through prepayment or default,

loan termination reduces the net budgetary resources

from FHA’s loan guarantees. Thus, accurate forecasts

of FHA’s guaranteed-loan terminations are essential to

correctly project cash flows and subsidies from the

credit activity.

Indications of Upward Bias in

Estimates of Net Collections

Two factors suggest that original estimates of FHA

subsidies may be subject to downward bias (overstatement of net income, which means understatement of

subsidy cost): the persistent direction of reestimates,

and the character of the forecasts currently used to

project future cash flows for FHA guarantees.

Reestimates

Under credit reform accounting, the federal budget

records outlays for the present value of expected cash

flows from guaranteed loans disbursed in the budget

year. However, actual cash flows are revealed slowly,

over the life of the guaranteed loan. Thus, credit reform also requires agencies to periodically revise their

initial subsidy estimates in light of experience to date.

The Office of Management and Budget (OMB) directs agencies with outstanding cohorts of loans and

guarantees to periodically reestimate subsidies by cohort as new information becomes available. Reestimates reflect actual cash flows and a revised forecast 

of future collections and outlays.

Reestimates provide additional information and correct the bias in initial subsidy estimates. Unbiased

original estimates will produce upward and downward

adjustments of approximately equal frequency and

3. See Congressional Budget Office, Credit Subsidy Reestimates,

1993-1999 (September 2000).

4. The actual interest reimbursement is based on the 30-year

Treasury bond yield at the time the loan was originated, rather

than the note rate on the mortgage.
SUBSIDY ESTIMATES FOR FHA MORTGAGE GUARANTEES 3

Table 1.

Original and Reestimated FHA Subsidy Rates, by Cohort, 1992 to 2002

(Percent)

Cohort Year Original Estimate Current Estimate

Difference (Original 

Minus Current)

1992 -2.60 -3.30 0.70

1993 -2.70 -2.57 -0.13

1994 -2.79 -1.60 -1.19

1995 -1.95 -0.58 -1.37

1996 -2.77 -1.00 -1.77

1997 -2.88 -1.31 -1.57

1998 -2.99 -2.07 -0.92

1999 -2.62 -2.47 -0.15

2000 -1.99 -1.43 -0.56

2001 -2.15 -2.13 -0.02

2002 -2.07 -2.74 0.67

Average -2.50 -1.93 -0.57

Volume-Weighted Average -2.48 -2.02 -0.46

Source: Budget of the United States Government, Fiscal Year 2004: Federal Credit Supplement, Table 8.

amount. In contrast, reestimates that consistently

move estimates in only one direction suggest that the

original estimates may have been biased. 

Reestimates of subsidies for FHA’s home mortgage

guarantees show a pattern of sizable upward adjustment (toward higher costs) across cohorts. As reported

in OMB’s annual Federal Credit Supplement to the

President’s budget, reestimates to date have lowered

the value of expected net income—that is, raised the

subsidy cost—for nine of 11 cohorts accounted for

under credit reform (see Table 1).5

 Reestimates have

reduced FHA’s negative subsidy from a weighted average (by volume of loans guaranteed) of almost 2.5 percent to about 2 percent. On nearly $900 billion in

mortgages guaranteed by FHA over the 1992-2002

period, that percentage difference amounts to $4 billion (or $365 million per cohort) in initially expected

net budgetary inflows that are no longer expected to

be received. 

Current Estimating Method

In the economic forecast that FHA uses to estimate

subsidy costs, interest rates and housing prices move

smoothly over the first 10 years of the 30-year forecast

period toward the long-run average for interest rates

and the rate of growth for housing prices.6

 Those variables are then held at their long-term averages for the

remaining projected life of the cohort. That approach

tends to understate the effect of economic conditions

on FHA’s loan terminations. Both interest rates and

housing prices exhibit period-to-period variation

rather than follow a smooth trajectory to their longrun average values. Those fluctuations generally tend

to increase both loan prepayments and defaults.

Therefore, a smooth economic forecast, used in conjunction with historically estimated effects of interest

rates on prepayments and of housing-price declines on

defaults, will underpredict prepayments and defaults,

resulting in an overstatement of expected (net) budget5. Budget of the United States Government, Fiscal Year 2004: Federal Credit Supplement, Table 8.

6. FHA does not develop that economic forecast itself. Rather, it

estimates subsidies from patterns of expected future loan terminations developed by a private contractor. See Deloitte & 

Touche, Annual Actuarial Review of the Federal Housing Administration’s Mutual Mortgage Insurance Fund, Fiscal Year 2001

(Philadelphia, Pa.: Deloitte & Touche LLP, December 2001).
4 SUBSIDY ESTIMATES FOR FHA MORTGAGE GUARANTEES

Table 2.

Original and Mean-Value FHA Subsidy Rates, by Cohort, 1992 to 2002

(Percent)

Cohort Year Original Estimate Mean-Value Estimate

Difference (Original 

Minus Mean Value)

1992 -2.60 -1.12 -1.48

1993 -2.70 -2.11 -0.59

1994 -2.79 -2.03 -0.76

1995 -1.95 -0.14 -1.81

1996 -2.77 -0.57 -2.20

1997 -2.88 -0.51 -2.37

1998 -2.99 -1.44 -1.55

1999 -2.62 -1.97 -0.65

2000 -1.99 -1.02 -0.97

2001 -2.15 -1.19 -0.96

2002 -2.07 -1.73 -0.34

Average -2.50 -1.26 -1.24

Volume-Weighted Average -2.48 -1.39 -1.08

Sources: Budget of the United States Government, Fiscal Year 2004: Federal Credit Supplement, Table 8 (for the original estimates), and Congressional

Budget Office (for the mean-value estimates).

ary inflows from FHA loan guarantees. Economic

forecasts more appropriate for projecting FHA’s cash

flows would incorporate realistic fluctuations in those

key economic variables throughout the life of the

guaranteed mortgages.7

Incorporating Volatility and

Multiple Economic Paths

CBO has developed a computer model that estimates

FHA-guaranteed subsidies using a large number of

different economic paths, each with historically observed fluctuations.8

 The version of the model used 

for this analysis creates 1,000 different economic paths

starting from the prevailing state of the economy in

the budget year. That large number of paths allows

CBO to calculate subsidy rates for a wide range of economic conditions, including sharp spikes in interest

rates and deep national recessions. The new model

also disaggregates national housing prices into 34 different regions. By doing so, it substantially increases

the sensitivity of defaults to declines in housing prices,

because regional prices are more volatile than the national average. Combined with the estimated effects

on prepayments and defaults, each path yields a

unique pattern of loan terminations and program cash

flows. Discounting each set of cash flows to the year in

which the cohort is disbursed produces a single subsidy estimate. The average of subsidy rates across all

economic paths is the budget subsidy rate for the cohort.9

Using the new model, CBO has calculated average, or

mean, subsidy rate estimates for each FHA cohort

from 1992 through 2002 (see Table 2). For every cohort accounted for under credit reform, the meanvalue estimate is lower in absolute value than the orig- 7. See, for example, Congressional Budget Office, A Framework

for Projecting Interest Rate Spreads and Volatilities (January

2000). 

8. That model is described in detail in Charles A. Capone Jr., The

FHA Budget Subsidy Simulation System: A Dynamic Simulation

Model of Budget Outcomes for FHA Single-Family Mortgage Insurance, CBO Technical Paper No. 2003-07 (July 2003).

9. The practice of probabilistic scoring (using a weighted average

of uncertain cost estimates by taking account of the probability

of each) is described in Congressional Budget Office, Estimating the Costs of One-Sided Bets: How CBO Analyzes Proposals

with Asymmetric Uncertainties (October 1999). 
SUBSIDY ESTIMATES FOR FHA MORTGAGE GUARANTEES 5

Table 3.

Original and Mean-Value FHA Subsidy Estimates, by Cohort, 1992 to 2002

(Millions of dollars)

Cohort Year New Loansa

Original

Subsidy Estimatea

Mean-Value

Subsidy Estimate

Difference (Original 

Minus Mean Value)

1992 42,120 -1,095 -472 -623

1993 62,502 -1,688 -1,319 -369

1994 91,813 -2,562 -1,864 -698

1995 40,142 -783 -56 -727

1996 59,221 -1,640 -338 -1,302

1997 61,175 -1,762 -312 -1,450

1998 90,518 -2,707 -1,304 -1,403

1999 113,174 -2,965 -2,230 -735

2000 86,274 -1,717 -880 -837

2001 107,449 -2,310 -1,279 -1,031

2002 136,382 -2,823 -2,359 -464

Average 80,979 -2,005 -1,129 -876

Source: Congressional Budget Office.

a. Subsidy estimates are for new guaranteed loans disbursed, rather than for new guarantee commitments issued in each cohort year. For budget preparation, the

“original” estimate is based on the projected volume of commitments, which differs from the volume of new guaranteed loans disbursed.

inal estimate, which implies that the original negative

subsidy rates were too high. As indicated by the simple

average of the differences, the original subsidy rates are

about twice as high as the estimates obtained using the

new model. Weighting those “errors” by the volume

of loans in each cohort (so errors in large-volume years

receive more weight) produces an average difference

between the two estimates of 1.08 percent. In dollar

terms, the total discrepancy between the original and

mean-value estimates (the volume-weighted difference

times $891 billion in guaranteed loans disbursed over

all cohorts) is $9.6 billion, or an average of $876 million per cohort. The dollar value of the difference between estimates for each cohort varies from $369 million to $1,450 million (see Table 3). 

Estimates for the 2003 Cohort

The 1,000 individual subsidy estimates per cohort that

result from using CBO’s model can be displayed as a

frequency distribution, with subsidy rates on the horizontal axis and frequency of occurrence on the vertical

axis. For the 2003 cohort, which has not yet been subject to reestimates, the mean of the distribution of estimates is -1.85 percent (see Figure 1). 

By contrast, the subsidy estimate for that cohort used

in the President’s budget for 2003 was -2.53 percent.

Because only 210 (or 21 percent) of the 1,000 estimates in Figure 1 are as low as that rate, the distribution of estimates indicates, with 79 percent probability, that future reestimates will increase costs and decrease expected receipts over the life of that cohort. If

the mean-value estimate is the actual value, downward reestimates of $908 million will be required on

$133,582 million of new guaranteed loans.10

The range of estimated subsidy rates for the 2003 cohort is wide, extending from -3.80 percent to 7.36

percent. (Because of the low frequency of large positive values, the figure is truncated at 3.75 percent.)

That wide range of subsidies corresponds to the extremes of past economic conditions. Yet the probability that the actual subsidy could be positive (and therefore costly to the government) is only 5.3 percent (53

of the 1,000 estimates), as indicated by the small area

under the curve to the right of zero in Figure 1.

10. The estimate of new guaranteed loans is from Budget of the

United States Government, Fiscal Year 2004: Appendix, p. 502.
6 SUBSIDY ESTIMATES FOR FHA MORTGAGE GUARANTEES

Figure 1.

Frequency Distribution of FHA Subsidy Rates for the 2003 Cohort

Source: Congressional Budget Office.

Two types of unfavorable events could drive the actual

subsidy rate into the extreme right side of the distribution. First, interest rates could drop sharply. Such a

decline would be expected to increase the volume of

prepayments in the 2004-2006 period as homeowners

refinanced with lower-cost mortgages, which means

that FHA would have to rebate a percentage of their 

initial insurance premiums. Those prepayments would

also reduce expected future fee income from guarantees. Even though a sharp increase in prepayments

could turn expected net income into a cost for a single

cohort, the overall effect on FHA’s finances might not

be so severe. If most of the prepaying homeowners

refinanced with new FHA-insured mortgages, the 

rebates paid out and the lost future premiums would

still flow to FHA as fee income on new loans. 

The second type of adverse event that could cause the

2003 cohort to be costly would be declines in housing

prices in one or more regions of the country. Prices

that fell sufficiently to reduce collateral values below

unpaid mortgage balances could increase defaults and

foreclosures and consequently push up insuranceclaim payments by FHA. Recoveries by FHA on sales

of foreclosed properties would also be lower under

that scenario. 

The distribution indicates that the probability of such

adverse developments for the 2003 cohort is only 5.3

percent, which means that a negative subsidy (a value

to the left of zero in Figure 1) is much more likely. In

general, the distribution of subsidy estimates is a useful supplement to the mean-value point estimate because it indicates the range of outcomes consistent

with past experience as well as the likelihood of favorable and unfavorable results.

Subsidy Rate (Percent)

Mean value

Frequency (Percent)

-4 -3 -2 -1 0 1 2 3 4

0

5

10

15

20

25
SUBSIDY ESTIMATES FOR FHA MORTGAGE GUARANTEES 7

Table 4.

Projected Total FHA Reestimates, by Cohort, 1992 to 2002

(Millions of dollars) 

Cohort Year

Total Projected

Reestimates

Reestimates

to Datea

Additional Projected

Reestimates

(Total Minus

Reestimates to Date)

1992 623 -295 918

1993 369 81 288

1994 698 1,093 -395

1995 727 550 177

1996 1,302 1,048 254

1997 1,450 961 489

1998 1,403 833 570

1999 735 170 565

2000 837 483 354

2001 1,031 21 1,010

2002 464 -914 1,378

Total 9,640 4,031 5,608

Source: Congressional Budget Office.

a. These reestimates are smaller than the net lifetime reestimates reported by the Office of Management and Budget because OMB’s reestimates include adjustments for guarantee commitments that did not result in new loan disbursements, proceeds from sales of pre-1992 loans in 1996 and 1997, and interest on

reestimates.

Implications

Consistent overestimation of expected net income

from new loan guarantees could give policymakers a

false indication of the budget surplus or deficit. Biased

estimates could also mislead FHA and the Congress

about the level of premiums or defaults that would be

consistent with break-even financial operation of the

Mutual Mortgage Insurance Fund. Although current

procedures include provisions for correcting errors in

original subsidy estimates, reestimates occur slowly

over the life of the cohort. For the 1992-2002 cohorts,

original subsidy estimates have increased by $4 billion,

but that is less than half of the total reestimate of $9.6

billion that will be required if the mean-value estimates from CBO’s model are correct (see Table 4).

The current method of estimating FHA subsidies also

has the potential to distort financial information in the

budget because the annual reestimates by FHA are for

all cohorts but are entered as a single adjustment.

Combining reestimates that tend to move in the same

direction can result in an adjustment that is large compared with account activity. For example, the reestimate for all cohorts recorded in 2002 was -$1.8 billion, or more than half of the absolute value of the

original subsidy estimate for the guarantees disbursed

in that year. 

FHA could incorporate economic volatility into its

subsidy estimates. If the model is correct, doing so

would improve the accuracy of the initial estimates

and of cost estimates of proposed changes in the terms

and conditions of FHA guarantees. It would thereby

reduce reestimates for each cohort and increase the

likelihood that net reestimates would be close to

zero.11

11. An issue beyond the scope of this report but worthy of investigation is the extent to which current estimating methods result

in biases for other programs. Parallels between FHA’s home

mortgage insurance and the direct and guaranteed housing

loans of the Department of Veterans Affairs suggest that those

activities could be susceptible to a related bias. Similarly, the

cost of small-business loans might be increased by taking account of variations in the pace of economic activity and interest rates.
8 SUBSIDY ESTIMATES FOR FHA MORTGAGE GUARANTEES

Taking account of economic volatility can reduce, but

not eliminate, budgetary uncertainty about the value

of expected cash inflows to the government from FHA

mortgage guarantees, which are used in the budget to

offset the cost of other housing programs. The remaining uncertainty stems from three factors. First,

mean-value estimates are point estimates of a distribution of values. Consequently, the mean-value subsidy

estimate will not exactly equal the actual subsidy. Reestimates will still be required.

Second, dollar volumes of projected inflows from

FHA guarantees are the product of two estimates: the

subsidy rate and the volume of loans guaranteed. The

volume is highly variable and difficult to predict before the end of the budget year, and year-over-year

changes of roughly 25 percent are common. Adopting

an unbiased estimate of the subsidy rate will not address the errors in projected loan volume.

Third, the valuation of cash inflows required under

the Credit Reform Act does not recognize the cost of

market risk (the tendency of those inflows to be high

during good economic conditions but low during less

prosperous times, when they are more valuable).

Mean-value estimates will not correct for that omission; thus, the value of FHA’s cash inflows will continue to be overstated. However, the cost of market

risk is excluded from subsidy costs for all credit programs, not just FHA’s.

This publication and others by CBO

are available at the agency's Web site:

www.cbo.gov