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Get ready for a taxpayer bailout of the Federal Housing Administration

Image credit: Kevin Shorter (Flickr) (CC BY-SA 2.0)

Image credit: Kevin Shorter (Flickr) (CC BY-SA 2.0)

The Wall Street Journal’s Nick Timiraos:

The Federal Housing Administration is expected to report this week it could exhaust its reserves because of rising mortgage delinquencies, according to people familiar with the agency’s finances, a development that could result in the agency needing to draw on taxpayer funding for the first time in its 78-year history.

This isn’t your granddaddy’s FHA. Back in the 1930s, it insured 20-year term loans combined with a 20% down payment. What’s more, FHA lending was backed by a rigorous property appraisal process. Not surprisingly, defaults resulting in claims were super low. From 1934 through 1954, notes AEI’s Ed Pinto, the FHA insured 2.9 million mortgages. During this period, FHA paid claims on 5,712 properties for a cumulative claims rate of 0.2%.

But these days, Timiraos writes, it’s backing borrowers with downpayments “of as little as 3.5%—loans that most private lenders won’t originate without a government guarantee.” And although it guarantees fewer mortgages than Fannie or Freddie, it has more seriously delinquent loans than either of them. Again, Timiraos:

Overall, the FHA insured nearly 739,000 loans that were 90 days or more past due or in foreclosure at the end of September, an increase of more than 100,000 loans from a year ago. That represents about 9.6% of its $1.08 trillion in mortgages guaranteed. …  The FHA never relaxed its underwriting rules during the housing boom, and its market share plunged as private lenders offered loans on much easier terms. But the agency saw business soar as the housing bust deepened, first in 2007, as private lenders retreated, and later in 2008 and 2009, as Fannie and Freddie tightened standards. Most of the agency’s losses now stem from loans made as the housing bust deepened. About 25% of mortgages guaranteed in 2007 and 2008 are seriously delinquent, compared with about 5% in 2010.

Every year the FHA’s annual audit estimates how much money the agency would need to pay off all claims on projected losses versus how much it has in reserves. Last year, that represented 0.12% of its loan guarantees. Federal law requires the agency to stay above a 2% level. But as Pinto and Peter Wallison explain in an paper earlier this year, that ratio actually understates the severity of the problem:

To put this in perspective, as recently as 2006, the FHA’s capital ratio was 7.38 percent. If this were a real capital ratio, a decline of this size would be bad enough, but the “capital” in the FHA’s capital ratio is not even made up entirely of tangible assets. It is primarily expected future insurance losses subtracted from current net assets and expected future insurance premiums over the next thirty years.

In fact, if the FHA were treated like a private insurer, it would already be insolvent with a total capital shortfall of nearly $60 billion. Also note that Congress poured fuel on the fire last year when it raised the FHA’s conforming loan limit to $729,750.

Clearly the FHA desperately needs reform with the overriding principle being that it should return to its traditional mission of being a targeted provider of sustainable mortgage credit to low- and moderate-income Americans and first-time homebuyers. Among Pinto’s suggestions:

1. The FHA needs to return to its traditional market share of 10% versus today’s 30%.

2. The worst performing  25% of its mortgages will likely have a claim rate of at least 15%. FHA should limit the worst credit risk categories to a maximum claim rate of half that.

3. The FHA should focus on homebuyers who truly need help purchasing their first home.The homes it finances should cost less than the median priced home for an area.  And first-time homebuyers should be limited to an income of less than 100% of area median income and repeat home buyers to an income of less than 80% of area median income.

7 thoughts on “Get ready for a taxpayer bailout of the Federal Housing Administration

  1. My first mortgage in 1974 was a low-downpayment VA loan insured by the FHA. (5 percent down? Less?) So Pinto could have given us claims-paid data for the 30 years ended 2003, and covering what would be, in fact, your dad’s FHA as opposed to your grandfather’s. And why didn’t he? Because home prices rose steadily in that period. In a matter of a year or two, the home I financed back then went from 95 percent loan-to-equity to 80-20 and then much lower still. People still got divorced in the 1970s, fell ill or lost jobs, but FHA was off the hook.

    Home prices today have FALLEN substantially, meaning there is no cushion in the case of divorce, illness, job loss. And the grand lesson here would be Duh!

  2. And to Soquel up the creek, without a Fannie or Freddie bailout, there would not have been a housing market because mortgages would have been as rare as diamonds. Actually it took a nationalized Fannie & Freddie, plus the Fed as buyer of last (only) resort of agency bonds. IIRC, the Fed bought over $1 trillion in agency debt, and it’s still doing it today because private MBS investors have not come back. And to state the government intervention correctly, taxpayers bailed out bondholders who reached for higher yields in the oughts confident that the govt would not let Fannie and Freddie fail.

  3. Todd Mason, I have no problem with Fannie and Freddie or the FHA as entities. However, there is ample evidence that members of both parties in Congress were not performing their oversight duties.

    The blog post I provided provides a nearly decade-long time-line showing that many knew in advance of the high potential for catastrophic failure.
    http://soquelbythecreek.blogspot.com/2010/02/fannie-freddie-and-you-as-secret-santa.html

    In a September 1999 article, the New York Times warned …

    “In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980′s.”

    Yet, a mere two months before the crash, the Chairman of the House Financial Services Committee and future author of Dodd-Frank said, “I don’t think that Fannie and Freddie are financially insolvent. I don’t think they need large bailouts.”

    Obviously, the oversight system had a catastrophic failure. It is either corrupt, incompetent, or incapable of performing its duty. We need a significantly more robust oversight mechanism.

  4. Life is too short to spend it correcting wingnut fairy tales, but …. Consider the charts here showing how many mortgaged homes have negative equity: http://www.zillow.com/blog/research/2012/11/14/negative-equity-falls-in-the-third-quarter-but-fiscal-cliff-could-derail-momentum/

    Then ask yourself, does the fact that 50 percent of all mortgaged homes in Atlanta are underwater reflect the number of subprime bums there that that rascal Clinton forced Fannie and Freddie to underwrite? Or is that the lenders doing cash-out refis for people in all economic strata did not anticipate home prices falling sharply and broadly? Zillow’s analysis of delinquencies shows a 50-25-25 split among starter homes, midscale and upscale, which probably reflects levels of financial resources rather than mortgage status.

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