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September 8th, 2009

(When) Will FHA need a bailout?

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The proverbial writing was already on the wall back in April when we asked, a few months ago, How much is FHA going to cost us?

The discussion surrounding the FHA’s current situation suggests that they have two options: either ask Congress for a bailout, or raise the premiums they charge their borrowers. The latter choice seems like a no-brainer except for the fact that Congress voted against risk-based pricing last August.

With the collapse of all but the ‘prime’ conforming loan markets (which also would have imploded without nationalization), FHA has again become America’s de facto subprime mortgage market. Over the past two years, FHA’s growth has exploded — and so has taxpayer exposure:

Skyrocketing growth in loans from the Federal Housing Administration and Ginnie Mae have helped support the mortgage market — but could leave taxpayers on the hook for massive new losses.

FHA-insured loans have more than tripled from 530,000 in fiscal year 2007 to 1.7 million thus far in 2009. The Government National Mortgage Association, which securitizes FHA loans, has boosted its mortgage-related issuance to $287 billion from $85 billion.

Yet during that same period, the FHA’s loan delinquency rate has climbed to 14.4% in Q2 from 12.6% two years earlier.

Adding to the concern, the FHA’s fund to cover losses has dropped to a projected 3% of insured loans. That’s a leverage ratio of 33-to-1, the level banking giant Bear Stearns was at before it failed.

That last bit is the most telling. Congress set a mandatory level of for FHA’s loan-loss reserves. If those reserves falls below the minimum, either FHA will have to get out of the loan-insurance business until it improves… or Congress will have to shore up the FHA reserves with cold, hard cash. That event is too well known as a taxpayer-funded bailout… and this one would be expensive, too:

We won’t know for sure where the FHA stands until it prepares a report when its fiscal year ends September 30, but some analysts believe it’s dangerously close to its minimum reserve level. Last year the estimated value of the reserve fund was $12.9 billion or around 3 percent of all FHA-backed loans.

We’ve watched, in our weekly editorial survey, how private lenders have steadily raised down payments on conforming loans. FHA-insured loans can still be had for as little as 3.5% down, since borrowers pay insurance premiums; if they default, FHA makes the lender whole.

FHA had begun to charge more to riskier borrowers in July 2008. Congress short-circuited risk-based pricing, however, last October, when it decided not to allow FHA to charge higher insurance premiums for riskier loans. Some agreed with that decision, pointing out that FHA mortgages would have become “unaffordable for many entry-level borrowers.” We think it should be self-evident by now, though, that there are just some people who shouldn’t be encouraged to buy a home in times of economic turmoil.

Do we need another expensive reminder of what happens when a lot of homeowners decide that falling or ‘underwater’ home values make it economically a better bet to just walk away from their mortgages?

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About the HSH Blog

HSH.com's daily blog focuses on the latest developments in the mortgage and housing markets. Our mission is to relate how changes in mortgage rates and housing policy, as well as the latest financial news, impacts consumers, homebuyers and industry insiders alike. Our 30-plus years of experience in the mortgage industry gives us an edge as we break down the latest changes in an ever-changing market.

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Tim Manni

Tim Manni is the Managing Editor of HSH.com and the author of their daily blog, which concentrates on the latest developments in the mortgage and housing markets.

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