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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It’s also nothing new. We’ve been reporting about problems with the foreclosure system for years. We gave a 2006 speech before the nation’s real estate regulators at the height of the real estate boom explaining why huge numbers of foreclosures were inevitable. (See: Toxic Loans: The Storm To Come)

On September 20th Bloomberg News reported that “Ally Financial Inc.’s GMAC Mortgage unit told brokers and agents to halt foreclosures on homeowners in 23 states including Florida, Connecticut and New York.” (See: Ally’s GMAC Mortgage Halts Home Evictions in 23 States)

In turn, Ally denied the story, saying that “recent reports have stated that GMAC Mortgage instituted a moratorium on all residential foreclosures in 23 states. This is not true. In fact, all new residential foreclosures are continuing in the ordinary course of business with no interruption in our usual practice.

“The speculation likely emanates,” said Ally, “from a direction previously given by GMAC Mortgage to certain of its outsource vendors to allow time to address a potential issue that was raised in a number of existing foreclosures challenging the internal procedure we used for executing one or more judicially required forms. This direction was to suspend evictions and REO closings where the related foreclosure could have been impacted by the same internal procedure. We are also reviewing certain previously completed foreclosures where the same procedure may have been used.”

The Washington Post then chimed in with two important stories:

First, on September 22nd, the Post reported that “some of the nation’s largest mortgage companies used a single document processor who said he signed off on foreclosures without having read the paperwork — an admission that may open the door for homeowners across the country to challenge foreclosure proceedings.”

The problem is that lenders are supposed to have an official review all paperwork to assure it’s correct and accurate before seeking a foreclosure. In the case of Ally, reported the Post, the “head of Ally’s foreclosure document processing team, 41-year-old Jeffrey Stephan was required to review cases to make sure the proceedings were legally justified and the information was accurate. He was also required to sign the documents in the presence of a notary.

“In a sworn deposition, he testified that he did neither.”

“The reason,” says the Post, “may be the sheer volume of the documents he had to hand-sign: 10,000 a month. (See: Ally Financial legal issue with foreclosures may affect other mortgage companies)

The next day, the 23rd, the Post gets to the heart of a central foreclosure issue:

“The nation’s overburdened foreclosure system is riddled with faked documents, forged signatures and lenders who take shortcuts reviewing borrower’s files, according to court documents and interviews with attorneys, housing advocates and company officials.”

The Post then explains that “during the housing boom, millions of homeowners got easy access to mortgages while providing virtually no proof of their income or background. Now, as millions of Americans are being pushed out of the homes they can no longer afford, the foreclosure process is producing far more paperwork than anyone can read and making it vulnerable to fraud.” (See: Amid mountain of paperwork, shortcuts and forgeries mar foreclosure process)

The Post headline is simply wrong. Shortcuts and forgeries don’t just “mar” the foreclosure process, they damage the legal system, cripple the courts and undermine public trust. Everyone deserves not only their day in court but also the expectation of fairness when they arrive, and that includes families facing foreclosure.

Not “Just” A Paperwork Problem

The fact that borrowers obtained financing with no doc or low doc loan applications has nothing to do with a foreclosure proceeding. Lenders created the mortgage programs which allowed such applications and literally wrote the loan documents — they’re composed by lots of lawyers “in the lender’s usual form,” an expression which means the lender writes the loan rules and requirements.

When lenders foreclose they have an obligation to meet all requirements. If lenders do not correctly process their own claims that’s not the fault of the borrower.

A foreclosure is not a minor matter. Courts have an obligation to assure that the loss of a home — literally tossing someone on the street with everything they own — is justified. If that means a slow process, so be it. If that means all requirements to foreclose must be met, then that’s what should happen.

Money

The looming problem for lenders — and for courts — has been the wholesale denial of borrower rights. This is not merely a problem with “paperwork” or a “technicality.” The court system has been unjustly used to throw people out of their homes. How much of a bigger issue could there be?

One inevitable by-product of the mortgage lawsuits which are sure to come will be instances where foreclosures are determined to have been unjustified. One has to ask: How do we compensate borrowers who have lost their homes and been humiliated? How much money represents “just” compensation? Is there enough lender money to pay such claims?

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The government is now trying to address this scenario, something which is common across the country, especially for those who bought during the past few years with little or nothing down, have toxic mortgages or who live in communities which are in the eye of the foreclosure storm.

The basic idea of a so-called FHA short refinance is to replace current loans with new and shiny FHA mortgages. The government’s plan is great news for homeowners, if it will work. But will it work? And if the plan does work will the government get stuck with a lot of FHA mortgages that will soon default?

New Twist

The government established the Making Home Affordable plan in March 2009 with the intent of refinancing as many distressed borrowers as possible. As of June about 1.3 million homeowners had started three-month trial periods with lower monthly costs and nearly 390,000 borrowers now have permanent loan modifciations.

This is good news for a lot of people because the average monthly loan payment for those in the program fell from $1,422 to $838. This is a big savings, but the Making Home Affordable program cannot save all homeowners. There are borrowers who simply do not have the income to make even smaller monthly payments. Some 520,000 homeowners have started the trials and then washed out. For them, foreclosure almost certainly looms ahead.

But what if the program was changed so that more borrowers could be eligible?

The Treasury Department and HUD have now come out with a new program to extend FHA loans to borrowers with negative equity. Such “enhancements” are scheduled to begin in September.

How It Works

The new program says if you’re a homeowner and owe more than the house is worth the government has a deal for you: Refinance into a sane and solid FHA loan. Here’s what you need to qualify:

1. You must be a homeowner (no investors allowed).
2. You must be current on your existing mortgage and it cannot be an FHA loan.
3. You must have a credit score above 500.
4. The existing first lien holder must write off at least 10 percent of the unpaid principal balance.
5. The refinanced FHA-insured first mortgage must have a loan-to-value ratio of not more than 97.75 percent of the property’s current value.
6. If there’s a second mortgage, then the combined balance of the first and second mortgage cannot be greater than 115 percent of the combined loan-to-value ratio.

7. You don’t qualify if you’ve been convicted of mortgage or real estate crime during the past 10 years (think of felony larceny, theft, fraud, or forgery; money laundering; or tax evasion).

Conflicts

Since the foreclosure crisis first began in 2007 the biggest question for lenders has been what to do with upside-down mortgages, situations where the property is worth less than the loan balance. Under the “enhancement” program, lenders would have to write off 10 percent of the existing mortgage balance to dump their loans.

In the case of the new government effort you’re just not going to see too many distressed homeowners getting new FHA loans. Two huge reasons stand out:

First, the borrower must be current on the loan. If the borrower has been making full and timely payments then the lender has no incentive to write-off a portion of the mortgage. The loan is performing, not distressed. To lenders, there’s no problem to “cure” and no reason to accept a loss. Since lender participation is voluntary you have to wonder why a lender would volunteer.

Second, in situations where there are two loans the junior lender under the program must allow the first loan to be refinanced and not move up to first place. But ask yourself: Why would a second lender agree to such an arrangement without compensation?

End Game

At this time the FHA program insures about 30 percent of all purchase money mortgages and 20 percent of all refinances. Given the rickety state of the housing market, and given common sense, nobody wants to do anything which would undermine the FHA program.

The enhancements announced by the government are unlikely to help many people because the requirements are self-contradicting and nobody wants the FHA to take on a bunch of high-risk loans. While the intention is good, the practical applications are remote and unlikely.

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The new form from HUD has raised a question among some lenders as to whether a pre-approval letter or a pre-qualification letter is also an enforceable loan commitment. The issue — say some lenders — is that they cannot possibly issue such a letter without a lot of information from the borrower, information which they cannot require.

Of course, when toxic loans were popular, lenders issued pre-approval letters, pre-qualification letters and entire loans without too much checking in the case of so-called no doc and low doc loan applications. The result was a big part of the mortgage meltdown, especially when a lack of documentation was combined with option-ARMs and interest-only financing.

So now some lenders — but not all — do not want to issue pre-qualification and pre-approval letters. This is a problem for real estate buyers because such letters — known generally as hand-holding letters — help assure home sellers that a would-be purchaser has at least met with a lender and can qualify for a loan.

Hand-holding letters are not loan guarantees because they invariably contain an “out” making them subject to “changing market conditions” or the need to review an appraisal, credit report, or whatever. However, many lenders continue to issue pre-approval and pre-qualification letters with the understanding that they are not promises to make a loan, just evidence that a borrower has met with a lender to discuss financing.

Worksheets

“A worksheet,” says FHA Commissioner David H. Stevens, “is a document issued by a loan originator that may include generic information regarding interest rates and loan fees, or a document that may provide additional information to the consumer regarding the cost of the overall transaction outside of loan fees that are disclosed on the GFE.”

However, says Stevens, lenders must use care when issuing a worksheet:

A worksheet may be provided to a customer for a rate quote if the consumer does not want to provide the information necessary to generate a GFE. However, loan originators should ensure the following: (1) to eliminate consumer confusion, a worksheet should not look like a GFE and should not lead the customer to believe that it is a GFE and (2) a loan originator should NEVER use a worksheet in lieu of a GFE.

A loan originator may also use a worksheet to provide the consumer with additional information about his or her loan transaction, such as the amount of cash needed to close, seller credits, and other non-loan transaction fees that would be helpful to the consumer.

In other words, borrowers can find value in a worksheet but it’s plainly not a good faith estimate, it’s not binding and if it is presented as a GFE or the equivalent of a GFE then go elsewhere for mortgage financing.

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When you refinance a mortgage you replace an existing loan with a new one. There’s no need to negotiate with the old lender because his mortgage claim will be extinguished. However, borrowers with toxic loans need to see if a refinance will set off claims for a huge prepayment penalty at closing, perhaps an amount equal to mortgage interest for six months.

Mortgage Modifications

Mortgage modifications come in several forms. First, we have loans which automatically self-modify — that’s the nature of an adjustable-rate mortgage (ARM).

Next we have mortgages where the lender voluntarily agrees to modify loan terms. Given that a mortgage is a contract such voluntary modifications are rare. Voluntary modifications might include changes in rates and terms, and also assumptions where one borrower takes over the debt of another with permission of the lender.

Tough Times

Because of the foreclosure meltdown we now have government-organized modifications under the Making Home Affordable program. In basic terms such modifications are open to those facing foreclosure or who have lost so much equity that financing to a new and lower rate is now possible outside the program.

Owners Versus Investors

When principal balances are reduced it’s possible for investors to face federal taxes on the unpaid balance, money that’s regarded imputed income. For example, if a $100,000 mortgage is settled for $75,000 then the unpaid $25,000 has traditionally be considered taxable income under federal rules. However, if the loan being modified is for a personal residence, then under Mortgage Forgiveness Debt Relief Act of 2007 the amount forgiven is generally not be taxed by the federal government. For specifics, please speak with a tax professional and be sure to ask about both federal and state policies.

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It is alleged that “Countrywide, one of the country

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Fixing the mortgage system is crucial if we’re to prevent another financial meltdown. If the mortgages are done right than mortgage-backed securities will also be right — and that means there won’t be worries regarding securities ratings or insurance. Lenders will not be stuck with overvalued properties and undervalued paper.

No less important, if we fix the mortgage origination system we will also protect borrowers. No more toxic mortgages which are at the heart of our financial problems.

Here are six steps the borrowers, lenders and government officials can take now, this week, to revamp the mortgage system.

First, in the past year a Nationwide Mortgage Licensing System supported by state regulators and the federal government has begun operations. In essence loan officers now have unique registration numbers even if they move from state to state. This means the name and registration number for a loan officer can be included in mortgage documents — and loan officer performance can then be graded in the same way that we have credit scores. It may well be that prudent investors will not want mortgages included in a mortgage-backed security from loan officers with a score below a certain level — and it may also be that lenders will not want to hire such poor performers. Of course, the same concept of registration and responsibility should be extended to mortgage underwriters.

Second, lending rules must be changed so that loan officers have a fiduciary obligation to borrowers, in the same way that lawyers have an obligation to clients and doctors have an obligation to patients. The creation of a fiduciary obligation for loan officers would mean that aggrieved borrowers could take loan officers and their lenders to court in the event of abuse, a system which seems to work well for virtually every other type of business. Members of the UpFront Mortgage Brokers Association already have adopted this standard and promise that they “will endeavor to act in the best interests of the customer,” disclose their fees up front and credit the borrower for cash they receive from third-parties.

Third, require that all loans be fully documented and that income and employment are verified. This would do away with “stated income” loan applications where lenders do not verify borrower income claims.

Fourth, have HUD set the interest rate and points for FHA loans — and post that information daily online. There’s no reason this can’t be done. In fact, until 1983 HUD actually did set FHA mortgage rates. Borrowers would then have an easy way to follow the market by using FHA rates as a benchmark.

Fifth, predatory lending is NOT a federal crime. Loan fraud — where a lender is abused — is very much a federal crime but predatory lending where a borrower is overcharged by a lender is entirely ignored by federal laws. The next time you hear a politician yammer about “predatory” lending ask if he or she would support a specific federal law against such activities.

Sixth, every mortgage-backed security which has a high level of foreclosures should be audited by the FBI to assure that all loans were properly underwritten. When that’s not the case then appropriate action should be taken against the lender, the loan officer, the underwriter and the Wall Street securities packager who were paid for such work.

Would these ideas work? You bet. Toxic loans would be impossible and there would be real penalties for abusing borrowers and investors.

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Really?

I have no doubt that some people would be elated by the return of liar loans and other forms of nontraditional mortgages. However, there are more than a few who would object including mortgage insurance companies, mortgage investors and perhaps even financial regulators.

But what about those poor souls who cannot document their income?

Nonsense. You mean these non-documenters don’t file taxes? If they file taxes they must have some records and if they don’t file taxes then why would a lender underwrite a loan for them?

It’s said that no doc loans are great for self-employed borrowers but I don’t see why. I’ve been self-employed since the earth first cooled and never had a problem getting a mortgage. I just provide my tax returns and whatever other information that will make the application easy for the lender to underwrite.

The financial statements of the self-employed are just not that hard to figure out. You just add back real estate depreciation, count 75 percent of rental income, check the returns and make a few other adjustments. No big deal. Underwriters do it all the time.

If toxic loans are coming back just who will be originating such financing? Not the hundreds of lenders who the Mortgage Lender Implode-O-Meter reports have gone out of business. Not Washington Mutual, now a part of JP Morgan Chase. Not Countrywide, now a part of Bank of America.

No less important, would YOU make a loan to someone who would not or could not verify their income? Does that seem like a really shrewd idea? Do you think lenders, investors and regulators have not noticed that so-called affordability loan products are at the heart of the mortgage meltdown?

Right, toxic loans will be back — maybe at about the same time that stores start selling succulent lead-covered toys once again.

For the full story, see No-Doc Loans Returning?

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I wanted to study journalism because it gave me an opportunity to travel and to meet interesting people. I have been a correspondent on Capitol Hill and at the White House, I have lived on an offshore drilling rig in pursuit of a story, I have spoken to an endless number of business leaders, senators and representatives and I have traveled to just-about every state.

There is also another aspect to journalism, the idea that reporters, columnists and the media in general are uniquely equipped to watch the government, corporations and institutions at work — and to freely report when such entities do right or wrong. The usual expression is that journalists should comfort the afflicted…and afflict the comfortable.

Jon Stewart is generally referred to as a comedian. His “Daily Show” is typically seen as entertainment. So-called serious journalists often look down their noses at Mr. Stewart.

They’re fools.

Every journalism school in the country should be studying the conversation between Jon Stewart and Wall Street commentator Jim Cramer. And so should every borrower, investor, senator, representative, regulator, shareholder, saver, and homeowner.

The Interview

Steward did exactly what journalists are supposed to do, he asked tough questions, in public, based on research and common sense. He took Cramer and the financial network, CNBC, to task for failing to fully tell the public of the risks and follies being pursued on Wall Street. Stewart essentially said the business media in general had been handmaidens and enablers of the banks and brokerages, largely repeating the what they said, doing inadequate research and rarely giving time or attention to the red flags which were so obvious.

Cramer, who is loud, bright and often insightful, had an open opportunity to defend his position. Look at the uncensored video of the show and judge what he said for yourself.

Everyone Was Responsible

At this point the claim is usually made that “everybody” is responsible for the current financial meltdown. Lenders loaned too much, borrowers borrowed too much, regulators regulated too little and journalists could only cover current events which, for several years, saw little but rising home values and stock prices.

The unstated point, of course, is that if EVERYONE was responsible than no one was specifically responsible.

This is junk.

You didn’t have to be a soothsayer to see what was coming.

Most community banks and credit unions refused to offer so-called “affordability” mortgage products, the loans with negative amortization, huge prepayment penalties and high-cost back-ends. Most homebuyers bought responsibly and borrowed no more than they could afford. They fully documented their income.

Many states wanted to halt rapacious lenders but could not because the lenders acted under the authority of the federal government and the federal government said the states could not over-ride federal authority, an authority established by the National Bank Act and confirmed by the Supreme Court in the 2007 Watters case.

Oh, and when was the National Bank Act enacted? That would be 1864.

The Real Issues

The real issues are very simple:

First, without exception every loan is supposed to be underwritten according to baseline program standards. This is the lender’s responsibility and a lot of lenders either repeatedly and routinely got it wrong or purposely failed to stop loans that should never have been made, highly-profitable errors that produced large executive bonuses, fat paychecks for loan officers and grossly overvalued stock.

Second, the Federal Reserve, under the Home Ownership Equity Protection Act (HOEPA), legislation passed in 1994, has the right under Section 129 to ban “unfair and deceptive acts or practices (UDAP).” In other words, had the Fed simply said that option ARMs, interest-only loans and stated-income loan applications were “unfair” and “deceptive” we could have prevented the current mortgage meltdown. It doesn’t matter what any other branch of government did or did not do, the Federal Reserve had an opportunity to stop the financial crisis and it absolutely failed to do so.

Third, in 2003 five federal agencies announced that they had “a plan to identify and eliminate outdated, unnecessary or unduly burdensome regulations imposed on insured depository institutions.” An official from the Office of Thrift Supervision brought a chainsaw to rip through mounds government paperwork. Could anyone miss the symbolism? Could any lender not understand that the new government policy was hands off, anything goes?

On The Record

I have repeatedly told readers since as far back as 2004 that “nontraditional” loans and practices were dangerous. Not just for borrowers but also for lenders and their shareholders.

I wish I had been wrong.

Every time I have written about rip-off mortgages I have gotten numerous emails from lenders telling me I didn’t “understand” the system.

High credit scores, they said, were a substitute for the lack of documentation. But credit scores are history, they don’t tell us what happens when mortgage payments rise 50 or 100 percent. They also didn’t say that lenders and loan officers got more money when they sold a loan with a stated-income loan application.

“Nontraditional” loan products simply reflected a new understanding of financial instruments, they said. You have to know about the secondary market, derivatives and mortgage-backed securities, I was told. And you have to look at the rates and the ability to provide financing for just about any buyer. Of course, more loan volume means more commissions and profits, something not usually mentioned.

You can see the uncensored Jim Cramer interview on the Daily Show by pressing here.

And to Jon Stewart, my congratulations — journalists ought to be ashamed that you had to do their job for them.

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The way you get loans with less down is to find a financially-strong co-signer, someone or something that will bail out the lender if you can’t repay your mortgage. Loans guaranteed by the VA, FHA or private-mortgage insurance (MI) all allow borrowers to buy with little or nothing down.

But — and you knew this was coming — insurance requires an insurance premium, so to buy with little down AND without the cost of insurance, borrowers and lenders during the past few years increasingly turned to piggyback financing or financing with a simultaneous second.

With porker financing you get a first loan for 80 percent of the purchase price and a second loan for 10-, 15- or 20-percent of the home’s value. The result is little or nothing down, plus no cost for mortgage insurance.

Who makes such second loans? Sometimes a second lender, but often the very lender who provided the 80-percent first mortgage and also finances a second loan for the same transaction.

Once-common piggyback deals are now increasingly rare. The reason: That second loan is immensely risky. If a home is foreclosed the odds are overwhelming that the entire value of the second mortgage will be lost. Unlike a first loan, of course, there is neither insurance to offset a loss nor the equity represented by a significant down payment to protect the lender.

The evaporation of piggyback loans is a marketplace “correction” that’s long been overdue. Such financing is cute and clever — but only when home values are rising. Since home values do not always rise, the once-popular piggyback loan is now toast, nicely browned on both sides.

With the virtual disappearance of subprime loans — and with a substantial decline in interest-only mortgages, option ARMs and stated-income loan applications — what we have today is your father’s mortgage marketplace: Take your pick: You can get a conventional loan or a mortgage backed by FHA, VA or private mortgage insurance. Exotic mortgages are out, piggyback loans have been barbecued and dull loans that borrowers can actually understand are back.

Unfortunately, some buyers will not be able to get financing or refinancing under the new standards or they’ll be forced to borrow less. That sounds fairly gruesome until you realize that prudent borrowing means fewer foreclosures and a gradual return to normal markets, things which benefit us all.

————————
Published originally by Realty Times on July 23, 2008 and posted with permission.

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