Another of FDR’s New Deal creatures is on the verge of needing to be bailed out. Spawned as part of the National Housing Act of 1934, the Federal Housing Administration (FHA) insures loans made by banks and other private lenders for home buying and building. Of course, FHA is not really engaged in a legitimate insurance business. As Murray Rothbard explains,
Insurance properly applies to risks of future calamity that are not readily subject to the control of the individual beneficiary, and where the incidence can be predicted accurately in advance. “Insurable risks” are those where we can predict an incidence of calamities in large numbers, but not in individual cases: that is, we know nothing of the individual case except that he or it is a member of a certain class.
Rothbard goes on to explain that if the adverse event is within the control of the individual beneficiary, moral hazard becomes an issue. Insurable risks are homogeneous and the number can be determined by an actuarial table. On the other hand, events on the market are heterogeneous, not random at all, but instead influence each other, and thus, not insurable at all.
Not to mention, no legitimate insurance company would remain in business maintaining reserves against claims of only two percent.
With the housing market crash continuing on government time, it should be no surprise that the FHA’s cash reserves have fallen to such a level that the odds are 50-50 the agency will run out of money and be looking to the Treasury to keep its doors open. Nick Timiraos reports for the Wall Street Journal,
The audit, to be released Tuesday by the FHA, estimated that the value of the agency’s reserves stood at $2.6 billion as of Sept. 30, down 45% from an already low $4.7 billion last year. The drop reflects the impact of rising home-loan defaults amid falling home prices, which together generate greater losses on the sale of foreclosed homes.
The FHA insures $1.1 trillion in mortgages. Federal law requires the FHA to have reserves above 2 percent, meaning the agency is supposed to have over $22 billion in reserves on hand. It has just over 10 percent of what’s required.
Timiraos writes that a 9 percent drop in housing prices next year will send the agency to the Treasury needing $13 billion. A 20 percent decline will require $43 billion from Treasury.
Robert Shiller predicts housing prices will drop 10 to 25 percent between now and 2014, swamping any 3.5 percent down payment FHA requires.
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Doesn’t Rothbard’s argument imply that car or life insurance would be subject to moral hazard as well? Of course nobody wants to crash their car or die early but there are definitely things you can do to lessen the risks of these things happening. Heck, even fire insurance would fall under this, since you can buy or build a fireproof house out of earth or concrete. Even the risk of loss in a natural disaster such as a flood or tornado can be made more or less likely to occur to an individual based on choice of location. Rothbard is clearly ten times smarter than me, so what am I not getting about his argument?
Not really, with risk takers covered by private insurance, not only do they pay higher premiums but also higher deductibles for claims.
Those who buy safer cars or homes in areas less prone to disaster pay lower fees for coverage.
Marine insurance is a fine example ship owners are strongly incentivised to have good safety systems and records because those that don’t pay such high fees for coverage that they are forced out of the business.
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One give away for a legitimate insurance company is that they set the rules so they never lose money. If they find that a large incidence of claims is costing them money, they will change the rules so that they still win. Homeowners, for example, now find that many insurers will not provide coverage for roof/water damages or losses if their shingles are 10 years or older, despite the fact that most shingles are guaranteed for at least 20 if not 30 years.
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