Wednesday, May 6, 2009

WSJ: FHA Loans the Next Housing Bust

Sometimes you just want to throw up your hands in the air... we just exited a disaster caused by low to no money loans to high credit risk borrowers - that give home buyers almost no skin in the game & a system where all lenders had to do was originate the loan to get paid ...then ship it off to someone else to bear the risk. And now, as a solution? We are institutionalizing the practice via the Federal Housing Administration (FHA). I don't get a system where we learn nothing from past mistakes... no actually I do get it, because as the banks ask, so will the politicians jump.

This will be the taxpayer losses of the next few years. We warned about the fraud that was coming in December [Dec 11, 2008: Freddie, Fannie Considering Waiving Appraisals for Refinancing]

As for FHA? Cmon now... we are going from semi government (Fannie/Freddie) to fully government "efficiency"? Cripes.

  • ...some housing industry experts worry that F.H.A. may soon be hit by a wave of mortgage-related fraud and abuse that it is ill prepared to deal with.
  • Over the years, the Department of Housing and Urban Development, which oversees F.H.A., has been slow to weed out mortgage lenders that abuse or defraud the agency and profit through means like certifying unqualified borrowers. (the circle of life - isn't this how we got here in the first place?)
  • There are also growing concerns that subprime fraud artists have set their sights on F.H.A. “It looks like an incoming tsunami,” said HUD’s inspector general, Kenneth M. Donohue.
  • The fallout for both homeowners and taxpayers could be substantial if F.H.A. becomes the next housing domino to teeter.
  • And a HUD audit released this month suggests that fund may soon face trouble again; over the fiscal year, its capital ratio dropped to 3 percent, from 6.4 percent, reflecting a sharp increase in claims. By statute, that capital ratio must be at least 2 percent.

It's not a surprise - we said Fannie, Freddie, and FHA will be used as the tool to prop up prices by offering "easy terms"... but it is so disheartening.

  • Everyone knows how loose mortgage underwriting led to the go-go days of multitrillion-dollar subprime lending. What isn't well known is that a parallel subprime market has emerged over the past year -- all made possible by the Federal Housing Administration. This also won't end happily for taxpayers or the housing market.
  • Last year banks issued $180 billion of new mortgages insured by the FHA, which means they carry a 100% taxpayer guarantee. Many of these have the same characteristics as subprime loans: low downpayment requirements, high-risk borrowers, and in many cases shady mortgage originators. FHA now insures nearly one of every three new mortgages, up from 2% in 2006.
  • ... taxpayer losses are mounting on its $562 billion portfolio. According to Mortgage Bankers Association data, more than one in eight FHA loans is now delinquent -- nearly triple the rate on conventional, nonsubprime loan portfolios. Another 7.5% of recent FHA loans are in "serious delinquency," which means at least three months overdue.
  • The FHA is almost certainly going to need a taxpayer bailout in the months ahead. The only debate is how much it will cost. By law FHA must carry a 2% reserve (or a 50 to 1 leverage rate), and it is now 3% and falling. Some experts see bailout costs from $50 billion to $100 billion or more, depending on how long the recession lasts.
  • How did this happen? The FHA was created during the Depression to help moderate-income and first time homebuyers obtain a mortgage. However, as subprime lending took off, banks fled from the FHA and its business fell by almost 80%.
  • The bill that passed last summer more than doubled the maximum loan amount that FHA can insure -- to $719,000 from $362,500 in high-priced markets. Congress evidently believes that a moderate-income buyer can afford a $700,000 house. This increase in the loan amount was supposed to boost the housing market as subprime crashed and demand for homes plummeted. But FHA's expansion has hardly arrested the housing market decline. The higher FHA loan ceiling was also supposed to be temporary, but this year Congress made it permanent. (we discussed this in detail last year when it passed, saying "temporary" would change to "permanent" once people saw just how bad the housing bust would be)
  • Even more foolish has been the campaign to lower FHA downpayment requirements. When FHA opened in the 1930s, the downpayment minimum was 20%; it fell to 10% in the 1960s, and then 3% in 1978. Last year the Senate wisely insisted on raising the downpayment to 3.5%, but that is still far too low to reduce delinquencies in a falling market. Because FHA also allows borrowers to finance closing costs and other fees as part of the mortgage, the purchaser's equity can be very close to zero. With even a small drop in prices, many homeowners soon have mortgages larger than their home's value -- which is one reason FHA's defaults are rising. (this sort of program, with almost nothing down in an environment when housing prices are falling rapidly is basically a recipe for "walk aways" - people are simply renting not owning in reality)
  • Every study shows that by far the best way to reduce defaults and foreclosures is to increase downpayments. Banks know this and have returned to a 10% minimum downpayment on their non-FHA loans.
  • In a rational world, Congress and the White House would tighten FHA underwriting standards, in particular by eliminating the 100% guarantee. That guarantee means banks and mortgage lenders have no skin in the game; lenders collect the 2% to 3% origination fees on as many FHA loans as they can push out the door regardless of whether the borrower has a likelihood of repaying the mortgage. (does this sound familiar to you? banks pushing out loans that they have zero responsibility for? Before it was securitization... now its simply the taxpayers obligation)
Think about this stat
  • The Washington Post reported in March a near-tripling in the past year in the number of loans in which a borrower failed to make more than a single payment.
This is the farce that home buying has become - instead or renting for 6 months with a lousy landlord looking over you "buy a home" and live rent free until they kick you out. Bought and paid for by taxpayer. Keep in mind all you need is FICO 620 to qualify for FHA.
  • The Veterans Affairs housing program has a default rate about half that of FHA loans, mainly because the VA provides only a 50% maximum guarantee. If banks won't take half the risk of nonpayment, this is a market test that the loan shouldn't be made.
  • These reforms have long been blocked by the powerful housing lobby -- Realtors, homebuilders and mortgage bankers, backed by their friends in Congress. They claim FHA makes money for taxpayers through the premiums it collects from homebuyers. But keep in mind these are the same folks who said taxpayers weren't at risk with Fannie Mae and Freddie Mac.
So as you read about all these home sales we are cheering, consider 33% of all homes bought "to live in" (not as investments which don't quality for FHA loans) are now originating under this program. So the half a trillion portfolio is growing by leaps and bounds each month. And then talk to me about the coming house recovery. It's a mirage - many of these homes (de facto rentals) will be handed back in 9, 12, 18 months; and the taxpayer will be on the hook for the obligation. But at least we are removing the middleman this time; no need for banks to take the hits on their balance sheets - the losses will be suffered directly by the taxpayer without making a pit stop.

I cannot stress enough: this is HOW WE GOT HERE IN THE FIRST PLACE - mortgage originators who had ZERO skin in the game had NO REASON to vet borrowers because it was NOT their obligation. They get paid simply to make the loans. All they had to do was bundle the loans in securitizations than sell the snake oil, labeled as low risk invesments, to buyers across the globe. That required new suckers to be born - now we can find no new suckers. Well, only 1. The US Taxpayer. And so we begin again the same path.

I give up on this topic. Buy stocks - everything is fine. Unlimited losses borne by taxpayer can fund everything in America. I'm not sure what level is below disgust, but that's where I am at.

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