Tags: FHA | bailout | mortgages | subprime

FHA: The Next Bailout?

By    |   Thursday, 13 December 2012 03:22 PM

Alan Zibel of The Wall Street Journal introduced a panel of experts at a Cato Institute Policy Forum about the Federal Housing Authority (FHA) by noting that a recent report by an independent actuary finds the FHA fund under water by more than $16 billion, and he asked whether the FHA should continue in the mortgage insurance business and what its role should be in serving low- and moderate-income borrowers.

Mark Calabria, former staff member of the Senate Committee on Banking, Housing and Urban Affairs and the Mortgage Banker and Realtor associations, explained the role of the FHA as the federal agency that provides 100 percent insurance for the credit risk of mortgages.

While the agency was established by the government as part of the post-Depression New Deal legislation, the mortgage insurance industry dates back to 1887. Underwriting standards were originally very high, with 20 percent down payments and a minimum interest rate of 5.5 percent, and racial politics were embedded in its underwriting policy, with loans targeted to Caucasian prime borrowers.

The social mandate of FHA was instituted during the 1960s. The agency was largely profitable until the 1980s, when foreclosure rates were higher than 20 percent and loss rates were over 40 percent, conditions even worse than the current state of FHA. Typically, loans guaranteed by the FHA would immediately be securitized, and the originator would never see it again.

Calabria suggested that the decline in underwriting standards, based on credit scores and down payments, is what brought the FHA to its present condition. In his opinion, the future depends on the ability of the FHA to increase the proportion of prime loans to subprime loans. As much as 80 percent of FHA mortgages have down payments of 5 percent or lower, and Calabria pointed out that this amount of equity would be insufficient even to cover the transaction costs of a sale, which are usually 6 percent or more.

Proposals for reform Calabria support would reduce the insurance from 100 percent to 80 percent and ultimately to 50 percent, require that mortgages that default in the first six months be put back to the originator and bring back the Appraisal Board that used to evaluate the quality of appraisals. Down payments should be increased to at least 10 percent as well.

Calabria finds that the FHA’s solvency depends on the assumption that prime borrowers will go only to the FHA and that future business will be profitable. He quipped that if the FHA were a state-regulated entity, it would already have been shut down.

He called the estimate of future volume “wildly optimistic,” and also dependent on rising house prices past 2019, whereas Calabria predicts that housing prices will peak again in 2016, and he faulted FHA for never having planned for a downturn in house prices.

Ed Pinto, a resident fellow at American Enterprise Institute and former Fannie Mae executive, warned that the response of the FHA to the housing bust has been to take on more risk, and that its current projections are vulnerable to increasing interest rates. In addition, as a government entity the agency is exempt from Securities and Exchange Commission disclosure standards. He accused the FHA of trying to grow its way out of the hole it is in, while its fiscal condition shows a generally accepted accounting principal shortfall of $47 billion in capital based on a 2 percent statutory requirement.

One in six FHA loans are delinquent today, and the agency is operating a reverse-mortgage program that is in even worse shape than its main program is, albeit smaller. He concludes that it would take two to three years for the fund to get back to zero, let alone meet the 2 percent capital requirement.

Therefore, Pinto expects that a bailout will be required in the $10 billion to $15 billion range, and that the 2 percent level won’t be reached for seven to eight years. In the event of a recession, which is due, the taxpayers would face catastrophic losses of $50 billion, assuming a mild recession.

Mike Fratantoni, vice president of research and economics at the Mortgage Bankers Association, acknowledged that the FHA is in serious condition. He quoted Acting Director of the Federal Housing Finance Agency Ed DeMarco as recommending that if congress is going to tackle reform of mortgage finance, the FHA would be the best place to start.

Fratantoni agrees that the fund will not achieve positive status for years, and if rates stay low, it will take even longer than the projected six years or more to reach the 2 percent level. He attributed a large portion of the losses to the seller-financed down payment program, but it was unable to terminate this business without an act of Congress. Fratantoni proposes locking in improved underwriting practices and higher premium charges while ramping up enforcement efforts against originators of bad loans.

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Alan Zibel of The Wall Street Journal introduced a panel of experts at a Cato Institute Policy Forum about the Federal Housing Authority (FHA) by noting that a recent report by an independent actuary finds the FHA fund under water by more than $16 billion.
Thursday, 13 December 2012 03:22 PM
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