Buy My Book Here

Fox News Ticker

Please check out my new books, "Bullied to Death: Chris Mackney's Kafkaesque Divorce and Sandra Grazzini-Rucki and the World's Last Custody Trial"

Sunday, July 27, 2008

The Perfect Storm: The Looming FHA Bankruptcy and the Bailout

During the refinance and real estate boom, FHA loans were one of the few sub set of niches to experience outstanding growth. That's because niches like sub prime and Alt A loosened their guidelines so much that FHA loans became nearly obselete.

The same thing that made FHA unattractive then maybe the crux of the problems that are coming now, Mortgage Insurance Premium (MIP). It is an up front fee of 1.5% charged by FHA at closing and also a monthly fee equal to .005 of the loan yearly. (in other words a $200,000 loan would have an up front fee of $3500 and $1000 yearly or $83.33 per month) Because sub prime didn't have either an up front MIP or monthly MIP, and Alt A didn't have an up front MIP and no monthly MIP on loans below 80% loan to value, this made both attractive when compared to FHA. Furthermore, FHA didn't allow for such things as stated loans. Once those two sub sets began to offer loans with little or no money down, FHA became very uncompetitive.

Of course, times have changed and sub prime and Alt A are nearly non existent. FHA is the only resource left for folks with little or no money down. It is also the place that the Dodd/Frank mortgage bill wants to place all the troubled loans that are now in or on the brink of foreclosure. (this is the corrupt bill that is about to pass and become law) Now, as this chart shows....

The default ratios for FHA are now becoming dangerously high already. With the addition of about $300 billion in new bad loans, it will be like adding gasoline to a flame.

This brings me back to this concept of Mortgage Insurance Premium. This healthy payment is actually paid to FHA itself. This goes into a pool to act as the insurance for loans that default. When defaults are .25%-.5%, there is plenty of money in the pool. Of course, defaults are already reaching past one percent, and FHA hasn't even done any loans for any of these troubled borrowers.

Once those borrowers are added to a mix of loans already too far into default it is already a matter of time before FHA is facing default. Of course, if the insurer is facing default, that puts every bank that will be heavy in FHA at risk. After all, FHA is insuring the loan in case the borrower defaults for the bank. Most of the loans will be originated by banks that are now facing their own liquidity crisis. These banks are counting on Dodd/Frank to bail themselves out just like the borrowers. They aren't going to be able to hold on to billions if not trillions worth of loans unless they are insured. Thus, we will again be facing a situation of a mortgage entity to vital to fail much like we are now facing with Fannie Mae/Freddie Mac. Only this time, the bailout with be hundreds of billions if not trillions.

Right now, both Fannie and Freddie are both tightening up their own guidelines such that FHA is going to become more popular than it was ever intended. Furthermore, there are still at least one trillion dollars worth of Adjustable Rate Mortgages that still need to adjust. Many of these folks will also be looking to get into FHA. All of these factors will combine to make FHA almost guaranteed to fail and so vital that we, the tax payers, will need to bail it out.


Anonymous said...

FHA loans are probably the most stable going right at the moment. FHA did NOT pick up sub-prime loans unless they met FHA guidelines.

Please confirm the sources for your information very, very carefully and document them on this site ASAP. Alarmist rumors are not helpful in the current financial climate.

mike volpe said...

They haven't picked up anything as this bill is NOT even law yet.

As for stable, that is sort of like saying that the drunk is the most sober one of his group.

I have given my hypothesis of what I think will happen based on my six plus years in the business.

I have however sourced everything about the impending bill known as Dodd/Frank.

Unknown said...

Something that has me wondering lately is the mortgage insurance business. When I had a loan that required mortgage insurance, I was told these premiums were to protect the bank in the event that I didn't pay back the loan. I always thought that the one who should be scrutinizing the loan were the insurance people as they were the ones ultimately on the hook for the money.

With all the defaults we hear about, I have not heard any mention of the insurance companies hurting due to the payouts from mortgage insurance. If these loans were insured, why are the banks taking the losses and not the insurance companies? If the mortgage insurance isn't paying the banks, then the customers (borrowers) who were forced to pay these payments have been defrauded. Am I misunderstanding how the non-FHA system works?

mike volpe said...

Good question, first of all, most times MI companies are the ones underwriting those loans. Often times, banks outsource their underwriting to these MI companies on all loans but that's only to save money.

That said, it isn't being talked about in the media but the MI companies are struggling like the rest of the industry.