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Will The FHA Go Bankrupt?

A new study says the FHA is likely to need a $50 billion bailout and perhaps as much as $100 billion. But is the FHA really in trouble? And if so, why?

The paper, written by Joseph Gyourko, a professor of real estate and finance at the Wharton School of Business at the University of Pennsylvania, says that while the FHA has not required a taxpayer bailout for more than 75 years it’s “highly likely” that public funds will now be needed.

The report, Is FHA the Next Housing Bailout? was commissioned by the conservative American Enterprise Institute. The study explains that the FHA is required to keep a reserve equal to 2 percent of its outstanding loans but that the federal program is now far below that level.

The FHA, says Gyourko, “presently is in violation of this capital guideline, as there were $879.875 billion in outstanding insured mortgage balances at the end of fiscal year 2010, so that the capital ratio was only 0.59% of outstanding insurance-in-force.”

What Professor Gyourko has documented is not the breakdown of the FHA but rather the failure to adequately regulate the mortgage marketplace. Let me explain why:

To start, the latest annual report from HUD says the FHA’s reserve — the Mutual Mortgage Insurance (MMI) Fund — could do better but it’s actually increasing in size.

“FHA’s total liquid assets (cash plus investments) grew by $800 million since last year, to $33.7 billion,” says the government. “That amount is $1.9 billion higher than at the end of FY 2009, and is also $7.7 billion higher than was predicted last year by the independent actuaries.”

Politics

The debate over the FHA’s financial status is curious. The Wall Street Journal shows the story under the category of “politics” and that’s right.

Something which is also right is the reaction of the Mortgage Bankers Association.

“It is clear,” says MBA Chairman Michael W. Young, “that the persistent troubles in the economy and real estate markets are continuing to impact FHA’s financial reserves, and given FHA’s mission of providing access to mortgage credit to lower income and first time homebuyers, it should be of little surprise that its reserves are being stressed.”


Housing Realities

In other words, it’s not the FHA program which is faulty, it’s the fact that the FHA program reflects the housing market.

The FHA insures mortgages. With FHA insurance borrowers can put down less money. In return for insurance the FHA charges a premium — generally 1 percent up front at closing and 1.15 percent annually on the unpaid balance. The mortgage insurance premium (MIP) paid by borrowers goes into a reserve — the Mutual Mortgage Insurance (MMI) Fund

When there’s a claim — when someone is foreclosed — the FHA pays off the lender. The money to make the payment comes from the reserve fund.

Today claims are larger than in the past for a very simple reason: Home values are falling. The government says home values nationwide are down 19.1 percent below the April 2007 peak and roughly the same as the February 2004 index level. If home values were steady or rising, claims would be far smaller and many could actually be paid off by simply selling the properties with no financial loss to the FHA reserve fund.

Why are home prices down? Because millions of “nontraditional” loans such as option ARMs were made by private-sector lenders, mortgages which were often originated with little or nothing down, no-doc loan applications and terms which assured that payments would soar. Meanwhile, the FHA, VA, credit unions and community banks kept their standards in place and did right by their borrowers and investors.

Further Steps

The FHA has taken several steps to better its financial position. It has gotten rid of seller-assisted down payments, raised the required down payment and changed the insurance premium schedule.

But the FHA can’t change a housing market which remains polluted with toxic mortgages, robo-signed foreclosure affidavits and electronically-traded mortgage notes which can’t be found. If it turns out that the FHA does need taxpayer help, it will be another example of collateral damage, a by-product of the vast mortgage scams which have undermined the housing market and the economy.

Despite the financial assault on borrowers and taxpayers it may well turn out that the FHA reserves will continue to increase.

“Barring a further significant downturn in home prices,” reports the government, “the MMI Fund will start to rebuild capital in 2012, and return to a level of two percent by 2014.”

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4 Comments on "Will The FHA Go Bankrupt?"

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  1. Russ Wetherill says:

    Peter,

    VA loans are made to veterans. Veterans tend to be more responsible than your average borrower. They tend to pay because their credit score can affect their employment as a DOD civilian. If the veteran put in their 20, they also have a military pension that helps to even out fluctuations in income.

    That said, the link you cited shows VA default rates at 6.58%! Is that what you consider a low default rate?

    Now the question is whether higher down payments would have decreased the number of VA defaults. Comparing the default rate of prime loans in that article to VA default rates, we see that VA loans default 50% more often than prime loans (6.58%VA and 4.32% prime). The main difference between VA loans and prime loans is the %down.

    There is also no mortgage insurance on VA loans which lowers the monthly mortgage payment relative to FHA loans or conventional loans with less than 20% down. Looking at the differences in borrower character, and loan terms, it is easy to see why VA loans default at a lower rate than FHA loans.

    All things being equal, I would agree with you that low default rates of zero-down VA loans would call into question the effect of down payment percentage on default rate. But, all things aren’t equal. VA and FHA borrowers are different. What’s good for the goose isn’t always good for the gander.

  2. Peter G. Miller says:

    Russ —

    Respectfully, I disagree. Lower down payments are not the cause of the FHA’s problems.

    If low down payments were the culprit, then how can we explain why the VA loan program — with as little as zero down — has the lowest foreclosure level, according to the Mortgage Bankers Association?

    See:

    http://www.mortgagebankers.org/NewsandMedia/PressCenter/78538.htm

  3. Russ Wetherill says:

    If FHA’s total assets are $33.7B, why aren’t they maintaining the 2% cash reserve level required by statute? They could easily transfer $15B to cash reserves by selling assets. Of course, that would just make FHA’s situation worse since cash pays zero in this economy.

    What is the point of having a statutory requirement, or any law for that matter, if the statute/law can be ignored when compliance is deemed too onerous by Congress?

    The problem with FHA isn’t the fact that every other loan outside FHA is bad, the problem is that FHA, by design, requires little or no down payment. On top of that, the FHA charges mortgage insurance payments every month. These mortgage insurance payments make sense when temporary in an appreciating market. The loan can be refinanced when 20% equity is reached. However, when little or no home equity is being built, it makes little sense to keep paying the mortgage on an underwater home, much less the insurance on that mortgage. That is why the FHA is going to need a bailout.

    FHA policies only makes sense in a rising market. Is another 20% drop in home prices being factored into FHA MIP, even today? Hardly. Notice the disclaimer in the last sentence of the article.

    When all the other loans go bad, housing prices drop, and the FHA takes it squarely on the chin.

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