FHA faces the music

Fresh warnings from the mortgage market indicate the worst is not yet over. The Federal Home Administration (FHA) is in some deep trouble, and bailouts are potentially in the works.

The share of borrowers who are falling seriously behind on loans backed by the Federal Housing Administration jumped by more than a third in the past year, foreshadowing a crush of foreclosures that could further buffet an agency vital to the housing market’s recovery.

About 9.1 percent of FHA borrowers had missed at least three payments as of December, up from 6.5 percent a year ago, the agency’s figures show.

Although the FHA’s default rate has been climbing for months and eating into the agency’s cash, the latest figures show that the FHA’s woes are getting worse even as the housing market shows signs of improvement. The problems are rooted in FHA mortgages made in 2007 and 2008. Those loans are now maturing into their worst years because failures most often occur two to three years after a mortgage is made.

If the trend continues and the FHA’s cash reserves are exhausted, the federal government would automatically use taxpayer money to cover the losses — a first for the agency, which has always used the fees it charges borrowers to pay for its losses.

The roots of this crisis go back a long way, perhaps to its beginnings in 1951. In testimony before the House last October, mortgage specialist Ed Pinto gave testimony that showed it already had a default rate of 2.36% in 1998 before heading to current levels approaching 5%. The agency has jacked up the fees borrowers pay for FHA loans to more than double previous year revenues — which of course reduces the amount of borrowing and depresses the housing market. But that may not be enough money still. And worse, as Pinto points out, increasingly those willing to pay the fee are exactly those you’d least like to loan the money to.

The loan portfolio FHA holds has clearly deteriorated, as shown by the rise in the share of mortgages with three missed payments. (This number was closer to 3% in the middle of the last decade.) And the capital level has now fallen to around 0.5% of assets, far below the statutory minimum of 2%. (I had reported on this in November.) Fees will perhaps cure this in the short run, but more likely continued foreclosures will chew up most of that money. Pinto thinks the FHA needs $40 billion in cash from the government, and there is nothing in the Obama budget to prepare for this possibility.

Peter Wallison put the blame squarely where it belonged last November:

The role of the FHA is particularly difficult to fit into the narrative that the left has been selling. While it might be argued that Fannie and Freddie and insured banks were profit-seekers because they were shareholder-owned, what can explain the fact that the FHA—a government agency—was guaranteeing the same bad mortgages that the unregulated mortgage brokers were supposedly creating through predatory lending?

The answer, of course, is that it was government policy for these poor quality loans to be made. Since the early 1990s, the government has been attempting to expand home ownership in full disregard of the prudent lending principles that had previously governed the U.S. mortgage market. Now the motives of the GSEs fall into place. Fannie and Freddie were subject to “affordable housing” regulations, issued by the Department of Housing and Urban Development (HUD), which required them to buy mortgages made to home buyers who were at or below the median income. This quota began at 30% of all purchases in the early 1990s, and was gradually ratcheted up until it called for 55% of all mortgage purchases to be “affordable” in 2007, including 25% that had to be made to low-income home buyers.

It was not easy to find candidates for traditional mortgages—loans to people with good credit records or the resources for a substantial downpayment—among home buyers who qualified under HUD’s guidelines. To meet their affordable housing requirements, therefore, Fannie and Freddie reduced their lending standards and reached into the FHA’s turf. The FHA, although it lost market share, continued to guarantee what it could, adding to the demand that the unregulated mortgage brokers filled. If they were engaged in predatory lending, it was ultimately driven by the government’s own requirements. The mortgages that resulted are now problem loans for the GSEs, the FHA and the big banks that were required to make them in order to burnish their CRA credentials.

The significance of the FHA’s troubles is that this agency had no profit motive. Yet it dipped into the same pool of subprime and other nontraditional mortgages that the GSEs and Wall Street were fishing in. The left cannot have it both ways, blaming the private sector for subprime lending while absolving the government policies that created the demand for subprime loans. If the financial crisis was caused by subprime mortgages and predatory lending, the government’s own policies made it happen.

Emphasis added; you can’t blame greedy lenders for FHA, because they were government officials. The Congress and the Administration are flat-footed on this one. They still can’t figure out what to do with Fannie and Freddie, and they are soon to add another agency to the list of those waiting for Godot.