CautiousInvestor's  Instablog

With recent news that the FHA is likely to breach its congressionally mandated capital ratio of 2%, I thought it appropriate to furnish some background on this government mortgage insurer who now enjoys a 23% market share in mortgage originations owing to its low downpayment requirement of 3.5% and its "tolerance" for less than gleaming credit scores. Gazing into my crystal ball, I see the FDIC going to Treasury to draw upon its line of credit; I see CRE crushing bank balance sheets and vaporizing all illusions of stability; and taxpayers bailing out the FHA.

FHA is a mortgage loan insurer that has stepped into the rather sizable vacuum the recent housing finance market collapse created. Inside Mortgage Finance reports that its market share has jumped from a paltry 3% in 2006 to a strong 23% in the second quarter of 2009. It has become very popular especially with first-time home buyers because of its as low as 3.5% down payment requirement and more accommodating underwriting guidelines. Those parameters, actually, have to be well-liked by all borrowers.

As real estate prices have been steadily sinking in several areas, among them of course Las Vegas, FHA's increased exposure in them is also bringing more losses. Mortgage Bankers Association, or MBA, enlightens now that by the end of June 7.8% of its insured mortgages were 90 days or more late or then already in foreclosure, while a year ago that figure stood at 5.4%. The trend clearly is leading in the wrong direction.

FHA is required by Federal law to hold cash reserves a minimum of 2%, counting anticipated losses, of its insured mortgage portfolio. In 2007 the quotient was a healthy 6.4%, but took an ominous drop to around 3% last year. Another indicator that gets government housing officials and others in the know talking, some of whom are suggesting tighter controls.

The mortgage arena is today by a large measure maintained by Washington, FHA itself having a good share of it and then there is the Fed that is by far the most active buyer of Fannie Mae and Freddie Mac paper on the secondary mortgage market. FHA could be pressured into tightening oversight just to abide by the law, and the 2% minimum, and that would put more strain on any nascent nationwide real estate recovery. That in fact is already evident, as the new commissioner recently took a firm stance toward a national FHA lender, suspending its charter.     

The housing market appears to be at a turning point for the better in many regions. That should help stabilize prices and therefore rein in any further losses at FHA. It then would be able to continue operating without too many new restrictions and provide further momentum to the budding recovery that everybody is anxiously waiting for.