FHA’s Growing Problems

Have we learned anything about the risks of mortgage lending over the past couple of years? If a Wall Street Journal article is to be believed, the answer is no.

The Journal focuses on the spectacular growth of FHA since Fannie and Freddie melted down and the troubling signs accompanying that growth:

Only last week, Ginnie announced that it issued a monthly record of $43 billion in mortgage-backed securities in June. Ginnie Mae President Joseph Murin sounded almost giddy as he cheered this “phenomenal growth.” Ginnie Mae’s mortgage exposure is expected to top $1 trillion by the end of next year—or far more than double the dollar amount of 2007. (See the nearby table.) Earlier this summer, Reuters quoted Anthony Medici of the Housing Department’s Inspector General’s office as saying, “Who would have predicted that Ginnie Mae and Fannie Mae would have swapped positions” in loan volume?

Ginnie’s mission is to bundle, guarantee and then sell mortgages insured by the Federal Housing Administration, which is Uncle Sam’s home mortgage shop. Ginnie’s growth is a by-product of the FHA’s spectacular growth. The FHA now insures $560 billion of mortgages—quadruple the amount in 2006. Among the FHA, Ginnie, Fannie and Freddie, nearly nine of every 10 new mortgages in America now carry a federal taxpayer guarantee.

Herein lies the problem. The FHA’s standard insurance program today is notoriously lax. It backs low downpayment loans, to buyers who often have below-average to poor credit ratings, and with almost no oversight to protect against fraud. Sound familiar? This is called subprime lending—the same financial roulette that busted Fannie, Freddie and large mortgage houses like Countrywide Financial.

On June 18, HUD’s Inspector General issued a scathing report on the FHA’s lax insurance practices. It found that the FHA’s default rate has grown to 7%, which is about double the level considered safe and sound for lenders, and that 13% of these loans are delinquent by more than 30 days. The FHA’s reserve fund was found to have fallen in half, to 3% from 6.4% in 2007—meaning it now has a 33 to 1 leverage ratio, which is into Bear Stearns territory. The IG says the FHA may need a “Congressional appropriation intervention to make up the shortfall.”

A lot of this isn’t new. FHA has historically incurred higher losses than did Fannie Mae (NYSE:FNM) and Freddie Mac (NYSE:FRE) and some private mortgage companies as well. Their mission was to help borrowers with meager resources — usually first time buyers — get into a house with a minimum down payment. They were, however, the last choice for borrowers as the monthly payment tended to be higher than conventional loan products.

This natural brake on the size of their portfolio combined with the relatively low loan amounts they were authorized to guarantee tended to limit the exposure of the tax payer. Yes there was risk there but it tended not to be budget busting risk.

But two events have come together to cause the situation to start spinning out of control. One, American’s are addicted to low down payment loans and FHA is the only one playing that game. And, two, Congress jacked the minimum loan amount up significantly. In California, FHA makes loans in excess ot $700,000. Put those two together and all of a sudden the possibility of incurring Fannie and Freddie size losses becomes real.

Sooner or later, this country is going to have to make a decision about how it wants to finance houses and how available they are going to be for purchase. Right now, the default position is biased towards easy finance with minimal investment by the buyer. We know now that only works in a strong economy with rising home prices. We have neither but we pursue the policy.

I suspect that we won’t have a serious discussion about this until the taxpayer revolts. There are only so many times they will let the politicians come back to the well. Maybe FHA will be that seminal event.

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