FHA reserves drop below Congressional requirement

Say, does this sound familiar to you?  A government lending agency gets mandated by Congress to get more aggressive in underwriting marginal loans in order to manipulate lending markets into giving out more credit.  The agency’s reserves drop below the red line, and then … what?  Thanks to the FHA, we’ll soon find out:

The Federal Housing Administration has been hit so hard by the mortgage crisis that for the first time, the agency’s cash reserves will drop below the minimum level set by Congress, FHA officials said.

The FHA guaranteed about a quarter of all U.S. home loans made this year, and the reserves are meant as a financial cushion to ensure that the agency can cover unexpected losses.

“It’s very serious,” FHA Commissioner David H. Stevens said in an interview. “There’s nothing more serious that we’re addressing right now, outside the housing crisis in general, than this issue.”

Until now, government officials have warned that the agency could be forced to ask Congress for billions of dollars in emergency aid or charge borrowers more for taking out FHA-insured loans if the reserves fell below the required level, equal to 2 percent of all loans guaranteed by the agency.

As Dina ElBoghdady explains for the WaPo, neither of those options are palatable for the Obama administration or Congress.  The American taxpayer is already angry about the bailouts of banks and the lending industry.  Thus far, Obama has been somewhat successful in blaming Bush for them, although his administration has certainly shoveled out bailout money with at least as much enthusiasm as the previous administration.  A bailout of FHA would be all on Obama, especially since it was his administration that pushed FHA to act.

Increasing fees won’t work, either.  That will disincentivize banks from lending, especially on marginal mortgages.  The housing market would decline once again, which would extend the recession or create a double-dip recession, depending on whether one believes Ben Bernanke that the year-long recession has actually ended.

The FHA faces a big problem at this level of reserves.  The mortgage failure rate at the moment is above the level of the reserves FHA has, which means that they could face collapse if the market turns even more sour.  That’s one big reason that hiking fees will be a last resort; they can’t afford to make the situation worse, and bigger fees could kill resales that keep current owners from defaulting altogether.  The push to get FHA to replace Fannie Mae and Freddie Mac has succeeded in the worst possible way, and FHA may find itself boxed into a position of collapse with no lifelines at hand.

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