FHA on the Brink

A new audit paints a very grim picture at FHA.

The Federal Housing Administration warned Thursday its capital reserves have tumbled below mandated thresholds due to heavy loan losses, raising worries about the need of a federal bailout.

An independent audit of the agency, which provides loans to many first-time home buyers, showed its capital reserve ratio slumped to 0.53% of total insurance in force this year, well below the 2% ratio mandated by Congress and the 3% ratio a year earlier.

However, the FHA said the study concluded that “under most economic scenarios,” the agency’s reserves would “remain above zero.”

The reserve ratio is how much the Federal Housing Administration has available from the mortgage insurance premium they charge compared to the total amount of the value of the loans they are insuring. The reserve ratio is supposed to be 2%. So, if they were insuring $1,000,000 worth of loans, there would need to be at least $20,000 in their reserves. Currently, it is .53%, or $5,300 in my example.

The minimum reserve ratio is meant to keep FHA solvent in case there's an influx of new foreclosures. It doesn't take much math skills to see that FHA is at a critical level if foreclosures continue to rise.

It's important to note again that FHA has not changed their underwriting guidelines. In fact, they've gotten a bit more stringent. This is happening entirely due to the current state of housing and the fact that FHA has taken on a new role with the disintegration of several alternatives.

Many people will point to FHA's low minimum of 3% down payment as the culprit. It's important to note that this minimum is not new. FHA was always meant to give those without a plethora of dollars the opportunity to own. So, to blame their low down payment is to miss the point.

Foreclosures are rising and that includes FHA. Beyond this, during the height of the refi boom, there was plenty of alternatives and FHA lost a lot of favor. Since the disintegration of sub prime and Alt A, FHA has seen a massive renaissance. It's the only alternative for those looking to put little money down. The amount of loans that FHA has taken on in the last two years or so has risen exponentially because almost all its competition has gone away.

Currently, in residential mortgages, there are only three alternatives, Fannie Mae, Freddie Mac, and FHA. In fact, the story of FHA is part of a larger story of a totally perverted mortgage market. Right now, there is scant competition in mortgages. As long as government dominates the mortgage market, we'll have this perversion and worse yet, we'll be forced to bail out all three whenever they get into trouble. The market, in its current state, simply can't survive without FHA. So, if it needs a bailout, we'll have no choice but to provide them one. Without it, the real estate market will disintegrate and the economy with it.

I have long called for breaking up Fannie/Freddie and fully privatizing them. Until that happens, there won't be nearly enough competition and all three: Fannie/Freddie and FHA will continue to be too big to fail.