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FHA Will Cost Taxpayers $150 Billion

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Over two months ago on these very pages I predicted the Federal Housing Administration or the FHA would end up being bailed out by taxpayers. Not an overabundance of prescience was required in reaching this conclusion. No government agency goes bankrupt of course…..they just ante up more taxpayer dollars to keep it alive……but with a current negative net worth of $16.3 billion and profuse bleeding continuing, a patient can endure loss of only so much blood before death ensues. On September 11 of this year the House overwhelmingly passed (402-7) a barely noticed piece of legislation, the FHA Emergency Fiscal Solvency Act of 2012. Besides all the gibberish about cracking down on fraud, improving transparency and internal controls within FHA, the only real reason for the Act was to increase annual FHA insurance premiums to 2.05%. Around the same time the administration’s 2013 budget projected taxpayers may have to contribute $668 million to backstop FHA losses. In our days of a $16 trillion in national debt this seems like petty cash especially when you consider that FHA alone insures $1.1 trillion in single family loans. Fast forward to today and in less than three months radically different words are being spoken at FHA overseer, Department of Housing and Urban Development (HUD). With the election now but a fleeting memory, a least parts of the financial truth seeps from the miasma in Washington. In the latest HUD report released in late November, FHA loans insured between fiscal 2007-9 now expect losses of $70 billion. That’s over a 100 fold increase in what we, the dumb public, were fed like pablum less than one quarter ago. Ed Pinto of the American Enterprise Institute, another accurate forecaster of FHA woes, reckons total agency loan delinquencies as of September 30 at 17.3%. The carnage, in my opinion will be some multiple of even this number. In my previous article I did some math on FHA portfolios at three of the largest loan originators, Bank of America (BAC), JP Morgan (JPM) and Wells Fargo Corp. (WFC). These three lenders alone hold $112 billion or 10% of all FHA insured loans on their balance sheets and in aggregate 45% of these are delinquent, meaning greater than 90 days past due. These three banks have a footprint covering 95% of America’s population. Were we to extrapolate these figures then this means potentially almost $500 billion out of $1.1 trillion could be past due. If just a 30% loss ratio ensued then you and I, the taxpayers, get to pony up $150 billion. Now this is some real money….a far cry from rosy projections and financial soundness continually promised over the last four years. To place this in some historical perspective, Fannie Mae and Freddie Mac have tattooed taxpayers for $138 billion. HUD Secretary and career policy wonk Shaun Donavan, since leaving Harvard with multiple degrees, as far as I could find has never had any meaningful employment in the private sector. Next time anything about numbers or economics gurgles forth from his smiling mug, I would think twice about listening.

Some History

Subprime lending, like a tapeworm, insidiously inched its way under our financial skin ushered in by none other than our own federal government. While difficult to obtain an actual birth certificate, sometime in the mid 1990’s a confluence of events set into motion what would culminate in the bursting of one of the greatest housing bubbles ever and a world financial meltdown not seen since the Great Depression. In 1992 the first whiff came when Congress issued an amorphous affordable housing “mission” to Government Sponsored Enterprises (GSE’s) Fannie Mae and Freddie Mac. Updated Community Reinvestment Act (CRA) regulations in 1995 required banks to demonstrate they were “making loans to underserved communities” so to comply, credit standards at mortgage originators were drastically loosened to well below criteria required to qualify for a conventional mortgage loan. Thus did the reinforcing downward spiral of credit quality through government mandates pushed its way into our financial system as banks and GSE’s now made or bought mortgage loans of far inferior standards. Even more perfidious, bank examiners from the OCC and the OTS (see below) closed the circle by tacitly approving (not classifying) these new low quality mortgages, and the words “subprime” loans entered our lexicon. In 2003 the House Financial Services Committee chair Barney Frank infamously announced, "I do not want the same kind of focus on safety and soundness (in regulating Fannie Mae and Freddie Mac) that we have in the Office of the Comptroller of the Currency (bank regulators) and the Office of Thrift Supervision. I want to roll the dice a little bit more in this situation towards subsidized housing." Well Barney got his way and credit began expanding faster than our universe. Leverage at the GSE’s reached 75 to 1 meaning there was a paltry $1.33 in capital to back up every $100 in loans or guarantees made. GSE’s were purchasing trillions in mortgages and were encouraged to do so. After all, in 2005 they received new HUD regulations mandating that 55% of all purchases must be in “affordable” housing and much of that had to be to “very low income” borrowers. Then Federal Reserve Chairman Greenspan lubricated the madness with artificially low interest rates. By 2007 over $1.6 trillion of subprime and Alt-A loans dominated GSE balance sheets. The crash came, traditional mortgage lending dried up, and housing prices collapsed. Then what?

The New Subprime Replacement Is Even Worse

While castigating commercial lenders for government induced forays into subprime lending based on the fallacy that everyone is entitled to home ownership, our dissembling leaders are openly running a Ponzi scheme of their own. The FHA program is merely the new subprime cloaked in a different moniker. If you put lipstick on the pig, it’s still a pig. In its current structure FHA is nothing more than a glorified rental program with effectively a free option to purchase. It may be no more difficult to qualify to rent an apartment than to receive an FHA loan. Standards have been so diluted that the program is little more than just one more in the infinite list of government entitlement programs. To get a perspective, the federal regulator’s guidelines for subprime credit are a FICO score of less than 660. That was the line of demarcation for Fannie

Mae.  FHA only requires credit scores of 580 and a 3.5% down payment which can be borrowed from friends, family, or an employer. To meet income requirements you can claim potential future income from a roommate to be named at some future later date.

If after a few months you can’t pay, do not be troubled. You are seamlessly transferred into the baneful Home Affordable Modification Program (HAMP). This means your payments will be “modified” (reduced) and possibly your principal reduced too. Do not despair if good economic fortune still fails to cast its rays upon you……more government largesse awaits. You may default yet a second time and be eligible for yet another loan modification. It should be noted that 49% of all reworked loans default again within twelve months. By my math, the more a borrower defaults, the lower his payments keep getting, so where lay any incentive to do the right thing and honor your contractual mortgage obligations? HAMP has an equally pernicious first cousin named HARP, Home Affordable Refinance Program. If you have a Fannie Mae or Freddie Mac backed loan securitized prior to June 2009 and you are current on payments and your loan is underwater, then bingo, you qualify. A loan must be above the value of the house….even far above, 100%, 200% or more, it really doesn’t matter. No appraisal is required.  These give aways fit neatly in the newly inculcated zeitgeist of America: No one is responsible for anything, so if you screw up the government will take the hit. It is an inexorable march to socialism creating a Pavlovian response mechanism of government dependence in contrast to self-reliance which is the backbone of American greatness. FHA is now the largest home loan program period.  This was assured when the loan limits of FHA were raised above those of Fannie Mae causing the disintermediation out of Fannie Mae. Why would any borrower ever borrow from a stringent Fannie Mae where a real down payment in conjunction with proper income verifications is required?

How It Got This Bad

How could such a well -intentioned program driven so very far off course? The theory was that after the crash of 2008 and 2009, with traditional outlets for home financing frozen, FHA would swoop in to the rescue to provide housing market liquidity to allow buyers to sop up all the millions of homes in excess inventory and thus prevent further deterioration in home prices. So it was and is really all about propping up home prices. I have talked with two homebuilders, who sell homes in the $250,000 to $400,000 range and virtually all of their loans are now FHA. Buyers have migrated away from private lenders that sell to Fannie Mae with its much more stringent down payment and income requirements. So nationwide, these low down payment sales, like the subprime of old, are already coming back to bite the hand that fed them. Placing defaulted FHA loans into the HAMP “system” is simply prolonging the day of reckoning. It is yet another example of an endless blend of government hypocrisy and profligacy. Like subprime, many of these people are not real buyers because they have no skin in the game and endless government relief when a default occurs. The solution is to get rid of programs like HAMP and let the foreclosure process take its course. All loan programs must require real down payments of 15-20% of the purchase price.  Home prices will find their true level, not artificial numbers created by entitlement loan programs such as FHA.

The government must reduce its footprint in the residential mortgage market and stop competing with private mortgage lenders. Only then will the market for private residential lending return to something more closely resembling equilibrium and allow taxpayers to be responsible for their own mortgage, and not their neighbor’s too.