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FHA - Just Another Government Mortgage Agency

On the tape (WSJ):

The federal government's mortgage-insurance agency is understating how much risk it has taken on, says a group of economists from the New York Federal Reserve and New York University, increasing the likelihood the agency may need taxpayer funds.

The economists warn that the Federal Housing Administration—which has jumped to fill the void left by the collapse of the private mortgage market—is overlooking factors that signal higher losses, according to a working paper released Thursday.

The agency has traditionally turned a profit for the U.S. government. But the economists warn that by underestimating the risks it faces, the FHA has increased the likelihood that it will have to ask Congress for money for the first time in its 75-year history.

The economists estimate that about 40% of mortgages insured by the FHA are worth more than the homes that secure them; as many as 14% of the loans may be for more than 115% of the home's value. The home-price measure used by the FHA puts the latter figure at 6%.

The FHA's share of the U.S. mortgage market has swelled. The FHA, which doesn't make loans but insures lenders against losses, backs about 25% of all home loans, up from less than 2% three years ago.

Loans backed by the agency are one of the few remaining ways home buyers can make low down payments. The FHA requires a minimum 3.5% down payment, while most private lenders require at least 10%.

The authors say the FHA's review doesn't accurately measure the share of its borrowers who may be underwater because it hasn't properly accounted for a jump in certain refinancing transactions. Those transactions, called streamline refinances, allow FHA borrowers current on their loans to refinance even if the value of the loan equals or exceeds the value of the home.

Streamline refinances, which became popular over the past year as home values plunged, accounted for about 21% of all FHA-backed loans last year, up from 6% the previous year.

The study concludes that at least 33% of borrowers who had a streamline refinance last year were underwater when they refinanced their loans, compared with an estimate of just 1.5% using the FHA's methodology.

Whats a couple billion for taxpayers? This just adds to the mortgage woes we have (and will) experience.

The question I have is what happens when the FHA has to actually underwrite their policies like a business and the Fed's purchases of mortgages stop?  I can't think that this bodes well for the MBS market.  Who is the next buyer of last resort?

Mortgages trading around +90 to swaps/strips has to make you wonder.

Thoughts?  Love to hear from mortgage guys.

Disclosure: no positions or insurance on my mortgage