FHA Bailout By Taxpayers On The Way

Taxpayers may was well brace for an FHA bailout. It is all but guaranteed. With current FHA practices it is likely to be a big one.

On November 5, the Richmond Register was asking What does the FHA think it is doing?

Exactly who made Bernadine Shimon think that she could buy a new house shortly after declaring bankruptcy and losing another home to foreclosure? The American taxpayer, that�s who.

Without a Federal Housing Administration willing to guarantee a $125,000-plus mortgage, this Denver-area schoolteacher�s recurring �dream of homeownership� could not come to pass. Shimon�s down payment was a tiny 3.5 percent.

This single mother is so strapped that she had to cash in her retirement savings to come up with the 3.5 percent. Her case was cited in a New York Times article about, not surprisingly, the sad shape the FHA finds itself in.

Of course, no sane private lender would take on such risk without a sucker-of-first resort, again the taxpayer. It happens like this: Private companies make their loans. The FHA buys the mortgages, and then rolls them into Ginnie Mae Mortgage Backed Securities. Sold around the world, these bonds are rock-solid investments because they carry an �explicit� taxpayer guarantee. Fannie Mae and Freddie Mac securities came with only an �implicit� guarantee (though as we saw in the recent bailouts, those �implicit� guarantees are for all intents and purposes �explicit�).

Much of the blame for the housing bubble-then-bust goes to these government agencies: They let private lenders make mortgages without adult supervision, then guaranteed them.

Kenneth Donohue, inspector general of the Housing and Urban Development Department, seemed to be shaking his head. �What does the FHA think it is doing by asking only 3.5 percent?� he asked. (FHA is part of HUD.)

With nearly a quarter of FHA loans insured in the last two years now in trouble, you�d think that the agency would show more discretion in deciding which homebuyers to help. And you�d think that Democrats running the House Financial Services Committee would be more upset over the way the FHA still hands out taxpayer guarantees.

But committee Chairman Barney Frank of Massachusetts insists that these mortgages are needed to �keep prices from falling too fast.� Thing is, we can�t support real-estate values with shabby lending practices. That�s what got us into trouble.

Another good idea is to demand that banks take a hit for the first 10 percent of losses on the mortgages they originate. That would put their skin in the game. It would spur them to engage in responsible lending practices -- and not just collect a bunch of fees upfront, then unload the risk onto the taxpayers.

Home prices are falling precisely because houses people bought homes they could not afford.

Note however, the thought process of Barney Frank: We have to keep selling houses to people who cannot afford them in order to keep home prices from falling.

That mentality all but assures a bailout of the FHA is coming. It will not take too much longer to realize it either.

FHA Says Cash Reserves Are Down Sharply

In light of the above, no one should be surprised by the New York Times headline Housing Agency Says Cash Reserves Are Down Sharply.

The Federal Housing Administration said Thursday morning that its cash reserves had dwindled significantly in the last year after a record drop in home prices.

Still, agency executives stopped short of saying that a direct bailout would be needed. The F.H.A., which insures loans made by private lenders, guaranteed more than $360 billion in mortgages in the last year, four times the amount in 2007.

�We are prepared to enact reforms that ensure the F.H.A.�s financial health,� the secretary of Housing and Urban Development, Shaun Donovan, said Thursday.

�As a credit expert, I have seen this movie before, and the ending is always the same,� said Edward Pinto, a former executive with the government mortgage giant Fannie Mae.

The results of the F.H.A.�s annual audit showed the agency�s capital reserves to be 0.53 percent, far under the 2 percent minimum mandated by Congress. A year ago, the capital reserves were 3 percent.

Nearly one in five loans made in 2007 are seriously delinquent, the agency said.

HUD FHA Report On Finances

Inquiring minds are considering preposterous statements made by HUD and the FHA in the HUD Secretary, FHA Commissioner Report On Finances.

�FHA is playing a critical role in restoring health to the housing market by helping working families access mortgage finance when private capital is tight,� said Secretary Donovan. �This is a temporary role which FHA has played in previous economic downturns. The Administration is committed to ensuring that the FHA steps back as private capital returns to the market. With this temporary increased role comes increased risk and responsibility. That�s why we are committed to closely monitoring market behavior patterns and economic risks so that we are prepared to enact reforms that ensure the FHA�s financial health moving forward.�

�There are real risks to the FHA and we are aggressively addressing those real risks with real reforms,� Commissioner Stevens said.

Changes Enacted via Mortgagee Letter, Effective January 1, 2010

• Require Submission of Audited Financial Statements by Supervised Mortgagees
• Modify Procedures for Streamline Refinance Transactions
• Require Appraiser Independence in Loan Origination
• Modify Appraisal Validity Period
• Enable Appraisal Portability

Unaddressed Issues

Do you see anything being done to address 3.5 percent down payments?
Borrowed down payments?
Seller assisted down payments?
Salary requirements?
Mortgage serviceability requirements?
Debt to income ratios?
Homeowner suitability?

On June 12, 2008, I wrote the Case for Abolishing the FHA and GSEs

In the case of the FHA, lives are being destroyed when they approve 65% DTI [Debt To Income] loans with borrowed down payments. Those loans are bound to fail, and are failing, leaving people will bad credit marks for years to come.

In regards to Fannie Mae, does anyone even remember what their mission statement is? Here it is:

We are a shareholder-owned company with a public mission. We exist to expand affordable housing and bring global capital to local communities in order to serve the U.S. housing market.

Fannie Mae exists to expand affordable housing.

Is there any doubt Fannie Mae has failed the mission? The mission HAD to fail. The very act of government sponsorship of housing contributed to rising home prices. Every affordable home program in history has failed.

Finally, the FHA and the GSEs are both moral hazards. Should either blow up, risk is high there will be a bailout at taxpayer expense. Now there is talk in Congress of expanding the role of the both. Instead, both should be abolished. Neither Fannie Mae nor the FHA serves any purpose that cannot be served by the free market.

At the time I wrote that, Fannie Mae had not officially imploded. It has since done so.

The FHA is on the same path. It's just a matter of time, and probably not much time at that. An FHA bailout by taxpayers is on the way. There's no stopping it now.

Addendum

The above appeared on Financial Sense on Thursday.

Since then I have been exchanging emails with Aaron Krowne at Implode-O-Meter regarding HUD and the FHA.

Aaron writes:

The bill to make the practice of seller-funded FHA downpayment assistance (SFDPA) legal was introduced in 2008 as HR 6694. It did not pass in that session of congress, so it was re-introduced as HR 600. HR 600 also left the implementation of a subprime-like fee structure to the FHA itself, rather than putting it out in the legislation where it was attracting criticism.

However, the Congressional Research Service during that session of congress came out with a rather scathing report on the seller-funded DPA practice. The CRS reports directly to congress, advising on legislation. Their advice seems to have been heeded. Indeed, there seems to be no continuance of HR 600 in the current session of congress. So thankfully that may have killed it.

However, the overall housing industry may have gotten essentially what they wanted in the form of the First Time (and now "Move Up") Homebuyer Tax Credit.

It is similar to SFDPA in that it gives "cash" to those who buy. It is also worth noting that something around half of ALL loans being issued now are through FHA (and of course, everything else is still backed by Fannie and Freddie, which are in government conservatorship) -- so this is still a major consideration for taxpayers.

Supposedly the money can only count towards some closing costs, not the downpayments -- but I'm not sure how enforceable that is. And we all know this is undoubtedly propping up home prices beyond fundamentals, so these people (who didn't have much up-front money in the first place) are at much higher risk of foreclosure.

The one plus side in all of this is that no longer are we letting third parties come in, launder money from seller to buyers, and specifically motivate mark-ups to cover the downpayment expense.

Calculated Risk addressed DAP (Downpayment Assistance Programs) in FHA on DAPs: "Too many homeowners not equipped for home ownership"

The FHA commented on the damage caused by the Downpayment Assistance Programs (DAPs) today. These DAPs circumvented the FHA down payment requirements by having the seller funnel the "down payment" to the buyer through a "charity" (for a small fee of course). The FHA attempted to stop this practice, but thanks to Congress, the DAPs led to billions of losses. .....

The 2009 vintage is just getting started, but the FHA has tightened standards (higher FICO scores), and DAPs were banned at the end of 2008 - and that will help. Also the stabilization in house prices is helping with fewer delinquencies.

However many of these recent homebuyers probably aren't ready to be homeowners, and the delinquency rate will probably rise sharply - especially if house prices start falling again.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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