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Friday, September 18, 2009

Is FHA Next? II

There's more troubling news regarding FHA loans.

The Federal Housing Administration has been hit so hard by the mortgage crisis that for the first time, the agency's cash reserves will drop below the minimum level set by Congress, FHA officials said.

The FHA guaranteed about a quarter of all U.S. home loans made this year, and the reserves are meant as a financial cushion to ensure that the agency can cover unexpected losses.

"It's very serious," FHA Commissioner David H. Stevens said in an interview. "There's nothing more serious that we're addressing right now, outside the housing crisis in general, than this issue."

Earlier in the month, I wrote about other signs of trouble in FHA loans.

Skyrocketing growth in loans from the Federal Housing Administration and Ginnie Mae have helped support the mortgage market — but could leave taxpayers on the hook for massive new losses.

FHA-insured loans have more than tripled from 530,000 in fiscal year 2007 to 1.7 million thus far in 2009. The Government National Mortgage Association, which securitizes FHA loans, has boosted its mortgage-related issuance to $287 billion from $85 billion.

Yet during that same period, the FHA's loan delinquency rate has climbed to 14.4% in Q2 from 12.6% two years earlier.

This latest news is much more troubling. It's the result of a confluence of events. First, since the collapse of sub prime and Alt A, FHA has gained significant favor. Back during the boom of the mortgage market there was a plethora of financing options. That left FHA battling for business on all fronts. Now, FHA is the only option available outside of Fannie/Freddie.

FHA allows purchases with as little as 3% down. Both Fannie/Freddie require significantly more than that. As such, FHA is the only option for folks that want to buy and put little money down. So, FHA is now the only option for those seeking aggressive loans. That puts a lot of new pressure on the mortgage program.

On top of this, since FHA has gone from one of many to one of few in the last two years, it's portfolio has a lot of fairly new loans. On top of this, it's dealing with a deteriorating market. Combine that with a portfolio that allows 97% loan to value, and you likely have a lot of underwater loans. Of course, we are dealing with rising foreclosures across the board. FHA is not immune to that either.

So, now what's in reserve is less than what is required by Congress. FHA receives its reserves from the Mortgage Insurance Premium it charges. It charges 1.5% up front and another .5% yearly. Congress requires that FHA have 2% of all their loans in reserve. Now, if FHA has a plethora of new loans, you can see that this would also contribute to the problem.

As the article mentions, FHA is in a politically uncomfortable situation. They could go to Congress and essentially get a bailout. Or they could increase their MIP limits on all new loans. Neither is a situation that the folks at HUD, those that administer FHA loans, want to deal with. Here is what the head of the program, David H. Stevens, is planning on doing to address the situation.

For one, he will propose that banks and other lenders that do business with the FHA have at least $1 million in capital they can use to repay the agency for losses if they were involved in fraud. Now, they are required only to hold $250,000. Second, he will propose that lenders also take responsibility for any losses due to fraud committed by the mortgage brokers with whom they work.

In my opinion, however, FHA's problems have little to do with fraud. This appears, to me at least, to be a trojan horse. FHA was never involved in stated loans. They strictly require documentation. FHA requires a more expensive and more detailed appraisal. Appraisers are required to get a special FHA license to do FHA loans. FHA can blame their foreclosure and insolvency problems on fraud, but in my opinion, FHA's problems are due to market conditions and its own underwriting guidelines. Furthermore, both these proposals will simply remove many banks from the FHA market and that will mean that interest rates on their loans will rise.

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