FHA: The Next Disaster?

The Wall Street Journal article about FHA’s declining reserve problem sparked a lot of comment today. The Journal said that FHA was in danger of falling below their 2% reserve requirement and FHA said that wasn’t the case at all.

From the Journal:

In the past two years, the number of loans insured by the FHA has soared and its market share reached 23% in the second quarter, up from 2.7% in 2006, according to Inside Mortgage Finance. FHA-backed loans outstanding totaled $429 billion in fiscal 2008, a number projected to hit $627 billion this year.

Rising defaults have eaten through the FHA’s cushion. Some 7.8% of FHA loans at the end of the second quarter were 90 days late or more, or in foreclosure, according to the Mortgage Bankers Association, a figure roughly equal to the national average for all loans. That is up from 5.4% a year ago.

Resulting FHA losses are offset by premiums paid by borrowers. Federal law says the FHA must maintain, after expected losses, reserves equal to at least 2% of the loans insured by the agency. The ratio last year was around 3%, down from 6.4% in 2007.

If its reserves fall short, the agency is obliged to notify Congress, which could spark a commotion over the extent to which the government is funding losses in the housing market. Some housing analysts have said losses might lead the FHA to pull back lending, which has helped boost flagging housing demand.

A senior official at HUD, which oversees the FHA, said there is “no risk” that the FHA would require money from Congress if the ratio falls below 2%. Asked about the agency’s capital ratio, the official said a report detailing that number won’t be completed until the FHA’s fiscal year ends Sept. 30.

And FHA’s response from Reuters:

“Even if that level falls below 2 percent, FHA continues to hold more than $30 billion in its reserves today, or more than 5 percent of its insurance in force,” FHA Commissioner David Stevens said in a statement. “Given this reserve level, FHA will not need a congressional subsidy even if the congressional capital reserve calculation falls below 2 percent.”

We’ve seen this rodeo before, haven’t we? Someone starts raising questions about the quality of a loan portfolio and the capital standing behind it, a lot of confusing numbers get thrown around by the institution in question as it assures us all that nothing bad could happen and you know the rest of the story. One would hope that this would lead to a proper investigation by Congress in which the real economic risk is quantified but don’t count on it.

The reality is that FHA has always taken too much risk. It missed the bubble not because it was smart or had better underwriting but because it was an afterthought. They weren’t making many loans. As the rest of the market melted, FHA has become the go to lender.

Even though the housing crisis has pretty well documented that no or low downpayment loans are a prescription for a disaster, FHA continues to make them. Though ostensibly they require a 3.5% downpayment, there are any number of ways around that. The $8,000 tax credit has only exacerbated the problem. Many local government programs allow for the tax credit to be used for a downpayment. Moreover, FHA allows for downpayment gifts from family members and certain other parties. It doesn’t take a whole lot of imagination to figure out that you can go to dear old dad and get him to fork over $8,000, sign a piece of paper that says it’s a gift, use that to buy the house, get the refund from the treasury and hand the money back to from whence it came with nobody being the wiser.

There is the chance we can dodge this bullett. FHA’s rapid growth is new and to the extent they’re lending at the bottom of the market, price appreciation may keep them away from Fannie (FNM) and Freddie’s (FRE) fate. It better because they’re piling on the risk and doing it in bigger chunks (they’re lending limit is way up). With little in the way of borrower equity going in, the only two things that can bail them out are price appreciation and a good economy. Neither one of those two has been seen around these parts lately.

Comments

[Spartacuss:]

It just amazes me, enthralls and disgusts simulataneously. Alice in wonderland economics.

So, if we are to understand what is going on, we are forced to conclude that the risks that brought the lending empires to their knees as a direct result of Congress' meddlings to bring about "affordable housing for the poor" have now being absorbed and subscribed to by government directly instead of indirectly.

In other words, it is the same poison medicine, but now served on a federal silver spoon. But, WE WILL HAVE AFFORDABLE HOUSING FOR THE POOR no matter what. And here I thought all along that one of the attributes of being poor was by not being able to afford a house. Owning a house isn't just the mortgage, no, no, it is upkeep too. Landscaping, furniture, repairs and insurance and taxes...can the poor who can't really qualify for a loan also qualify to be responsible neighbors and keep their place up...I hardly thnk so.

In fact, we must come to realize that for the most part the poor are poor for a reason. Now I wonder what that might be.

However, it seems to me that it is basic. If you want a house, the first thing is a) be responsible, b) stop being poor.

I used to be poor...very, no housing, not even a meal in a given day sometimes. It is hell to be poor and so I said, "enough already". So I worked and worked and worked and studied and learned and without the money to go to college I had to teach myself engineering and business; working two jobs and studying till wee hours. I did it, so can anyone if they want to.

Stop the handouts, stop free whatever, stop the nanny state and most of all STOP OBAMA!

We, the taxpayers are NOT OUR BROTHERS KEEPERS. For the unfortunate, yes help them, but that is charity and should remain charity by individuals for individual causes.

No one has rights to things at taxpayer expense and so this money charade by government is going to have a disastrous end for everyone and that includes, and especially includes, the poor.

Sep 05 03:48 PM

[whidbey:]

Smartcuss is a self-made man and deserves credit. But his case is not this case.

Yes, FHA is a problem. It is part of the Federal Charade to the effect " yes we can be everything to the voters". When no one will loan funds to the GSEs directly, and the Fed can not offer Trap funds, and Treasury will not touch them, FHA will stop and wait and wait; it is called zombie banking. All the GSEs will be monuments to the greatness of your Congress. The Ice Age comes soon to many, many federal programs. They just stop.

Sep 05 04:47 PM

[Bob Newton:]

Affordable housing is a red-herring, a con. Giving folks cheap loans to buy houses does little more than bid-up the price of housing. If we can bring new buyers into the market, and they bring even a modicum of their own cash, the effect is a little larger.
The $8,000 credit is more of the same.

The enticed poor acquired debt, when they had none.

Let's hear those sincerely interested in affordable housing speak out in favor of letting housing prices continue to slide. Their dream could finally come true. .... Silence. No, that's not really what they wanted.

Instead they make plans to keep people in their homes -- that is keep them in their mortgages. When you hear proposals to adjust payment schedules to "what they can afford", you should understand the purpose is to extract exactly 100% of what they can afford.

Sep 06 12:39 AM

[sethmcs:]

Really want affordable housing? Raise the prime rate to 15%. Everyone thinks in terms of payment rather than price. High interest rates would knock real estate prices down to affordable levels.....for those with cash.

Sep 06 01:10 AM

[grey road:]

Finally! Someone who gets the real estate market! I am in Canada where we still have seen little or no decline in the ridiculous prices of real estate. People have still been jumpy this summer buying because they think prices just wont fall and of course low interest rates. I am happy renting my house for $700 a month until I see something suitable that can be bought with cash. I suspect I will come out smelling like roses.


On Sep 06 01:10 AM sethmcs wrote:

> Really want affordable housing? Raise the prime rate to 15%. Everyone
> thinks in terms of payment rather than price. High interest rates
> would knock real estate prices down to affordable levels.....for
> those with cash.

Sep 06 09:19 AM

[Doug Francis:]

A number of my clients have opted to use FHA financing. My question is that no one seems to talk about the required up-front insurance (MIP) that buyers need to purchase... is it a "shell-game" since it can be financed? It is approximately 1.5% of the loan amount which adds up to a nice premium for these loans.

In the late 1990's, many banks came up with alternatives to FHA with 3% down and no PMI. These products killed FHA loans for years.

Sep 25 08:54 AM