Wednesday, August 12, 2009

WSJ: The Next Fannie Mae - FHA/Ginnie Mae

We've written often how there is no cost-benefit analysis anymore. It is just benefit-benefit analysis... the costs are not to be worried about until they hit someday in the future. I am not just talking about the stock market, but American society as a whole. We want our cake, to eat it, get seconds, and then have the pill that makes the costs go away. No need for exercise that way.

As we watch housing "recover" no one thinks about the costs - the handouts for 1st time home buyers, the perverse interest rates (again) that devastate savers to benefit borrowers, and what is happening on the balance sheets of (before) Fannie, Freddie [Sep 7, 2008: Bailout Nation Continues - Fannie/Freddie Now Owned by You] and (now) the Federal Reserve, FHA (Federal Housing Administration) and Ginnie Mae. And it won't matter... until it matters. But a bailout will be coming again - we are simply REPEATING all the ills we did via the banks, only now directly with the government. Essentially we are institutionalizing at the government level almost all the same actions that got us here in the first place. It is beyond amazing at this point. And when it implodes we'll ask "how could anyone see this coming?"

My personal belief at this point is it is on purpose - people in power know what they are doing now will come back to bite us, but the taxpayer of the future will bear the pain and the politician, constituent, and "society as a whole" benefits today. Because short term pain cannot be allowed to happen. I thought at first we do not learn lessons but I see now we know what we are doing - we are just content to enjoy the benefits today and have someone else pay for it in the future.

So think of it as a subsdization scheme - in return for large costs in the future, we get cheaper homes, 3.5% down, low rate loans , "no skin in the game" mortgages. And for all that, all we must suffer through is another bailout down the road. The exact same scheme that got us going in 2004-2007; I mean weren't those excellent times worth the small price we had to pay? If you are a debtor the answer must be yes - many now can walk away from their problems or have the taxpayer subsidize their mistake. And so we shall repeat again.

We've talked about the evil things going on inside the FHA before... this will be the nexus of the next housing bust as we sit and bail out Fannie and Freddie today. [May 6, 2009: FHA - The Next Housing Bust] We've explained before how the #1 reason people give up on their houses is not "bad interest rates" but NOT HAVING skin in the game. [Jul 6, 2009: WSJ - No Money Down or Negative Equity Top Source of Foreclosures] Now the majority of loans in the US are through FHA - where 3.5% down is enough. In a country where housing prices are mostly still falling - so you can do the math at how quickly these people will be underwater. And many "new homeowners" don't even need a 3.5% drop in housing prices to be underwater versus their investment. Many states now allow the 1st time tax credit to be used as a down payment; with the median home price now in the mid $100Ks, the $8000 tax credit pretty much means you can cover closing costs and down payment via handout from fellow taxpayer, and show up with no savings and become a "homeowner".

  • But this time, reckless financial innovation isn’t being hatched on Wall Street. Instead, state governments are angling to “monetize” first-time homebuyer tax credits so borrowers can purchase homes with little or no money down. If this sounds eerily similar to the type of lending practices that got us into this mess, well, it should.
  • In an effort to boost home buying -- even for marginally qualified borrowers -- a number of states are finding creative ways to advance the tax credit to buyers on the day they get their new keys, rather than having to wait for next year's refund check. This allows buyers to pay for things like closing costs, mortgage points - or even the down payment.
  • Not surprisingly, local real-estate professionals are behind the initiative. Washington Association of Realtors president Bill Riley told the San Francisco Chronicle he believes around half of would-be first-time buyers in his state “cannot save enough money for the down payment and closing costs.”

Heck the federal government even changed the rules AFTER the fact to nationalize this same scheme (before apparently reversing it a few weeks later - I am unclear why) [May 13, 2009: Tax Credit as Mortgage Down Payment Now Official Federal Government Policy] But the states continue to do it. And this what we are cheering on Wall Street - "housing rebound" via handoff of money from taxpayers to the "new homeowners". Basically the same as cash for clunkers - handouts to get people to consume.

We've lost the whole concept of home ownership - i.e. people who save money over a time, and have a cushion turn from renters to home owners. With all the schemes we've enacted almost anyone can now become a homeowner. That's our solutions to overbuilding and overspending. The irony here is the banks have sobered up and actually act rationally now but the US is not able to function without easy money. So the government and Fed have stepped into the place of the banks bad behavior, and are doing those behaviors themselves. (90% of the mortgages now are coming through Fannie, Freddie, Ginnie/FHA). As if the outcomes won't be identical in a few years?

There is an excellent opinion piece in the Wall Street Journal that ties together many thoughts we've expressed on the blog. So while we cheer the "housing recovery" (remember no costs, only benefits) we'll just post these type of entries so we can look back in a few years and smirk. Since we only look at benefits (market is up!) and forget the cost (literally trillions of taxpayers money in handouts and backstops) [Mar 31, 2009: Bloomberg - Financial Rescue Pledges Now $12.8 Trillion] its a small price to pay so a portion of the society can benefit from higher equity prices.

So let's enjoy our cake (benefits), and just add the FHA / Ginnie Mae bailouts of 2012, to add to the pension bailouts, and the state budget bailouts we have to deal with next. Costs are for someone else to deal with... not sure when those "someones" figure out the scheme.


Full WSJ piece below - it is that good... if you know of any "someones" who do not want to pay the bill for their fellow citizen, probably best to let them know about this piece so they can share it with their local Congress folk.

Much to their dismay, Americans learned last year that they “owned” Fannie Mae and Freddie Mac. Well, meet their cousin, Ginnie Mae or the Government National Mortgage Association, which will soon join them as a trillion-dollar packager of subprime mortgages. Taxpayers own Ginnie too.

Only last week, Ginnie announced that it issued a monthly record of $43 billion in mortgage-backed securities in June. Ginnie Mae President Joseph Murin sounded almost giddy as he cheered this “phenomenal growth.” Ginnie Mae’s mortgage exposure is expected to top $1 trillion by the end of next year—or far more than double the dollar amount of 2007. Earlier this summer, Reuters quoted Anthony Medici of the Housing Department’s Inspector General’s office as saying, “Who would have predicted that Ginnie Mae and Fannie Mae would have swapped positions” in loan volume?

Ginnie’s mission is to bundle, guarantee and then sell mortgages insured by the Federal Housing Administration, which is Uncle Sam’s home mortgage shop. Ginnie’s growth is a by-product of the FHA’s spectacular growth. The FHA now insures $560 billion of mortgages—quadruple the amount in 2006. Among the FHA, Ginnie, Fannie and Freddie, nearly nine of every 10 new mortgages in America now carry a federal taxpayer guarantee.

Herein lies the problem. The FHA’s standard insurance program today is notoriously lax. It backs low downpayment loans, to buyers who often have below-average to poor credit ratings, and with almost no oversight to protect against fraud. Sound familiar? This is called subprime lending—the same financial roulette that busted Fannie, Freddie and large mortgage houses like Countrywide Financial.

On June 18, HUD’s Inspector General issued a scathing report on the FHA’s lax insurance practices. It found that the FHA’s default rate has grown to 7%, which is about double the level considered safe and sound for lenders, and that 13% of these loans are delinquent by more than 30 days. The FHA’s reserve fund was found to have fallen in half, to 3% from 6.4% in 2007—meaning it now has a 33 to 1 leverage ratio, which is into Bear Stearns territory. The IG says the FHA may need a “Congressional appropriation intervention to make up the shortfall.

The IG also fears that the recent “surge in FHA loans is likely to overtax the oversight resources of the FHA, making careful and comprehensive lender monitoring difficult.” And it warned that the growth in FHA mortgage volume could make the program “vulnerable to exploitation by fraud schemes . . . that undercut the integrity of the program.” The 19-page IG report includes a horror show of recent fraud cases.

If housing values continue to slide and 10% of FHA loans end up in default, taxpayers will be on the hook for another $50 to $60 billion of mortgage losses. Only last week, Taylor Bean, the FHA’s third largest mortgage originator in June with $17 billion in loans this year, announced it is terminating operations after the FHA barred the mortgage lender from participating in its insurance program. The feds alleged that Taylor Bean had “misrepresented” its relationship with an auditor and had “irregular transactions that raised concerns of fraud.”

Is anyone on Capitol Hill or the White House paying attention? Evidently not, because on both sides of Pennsylvania Avenue policy makers are busy giving the FHA even more business while easing its already loosy-goosy underwriting standards. A few weeks ago a House committee approved legislation to keep the FHA’s loan limit in high-income states like California at $729,750. We wonder how many first-time home buyers purchase a $725,000 home. The Members must have missed the IG’s warning that higher loan limits may mean “much greater losses by FHA” and will make fraudsters “much more attracted to the product.”

In the wake of the mortgage meltdown, most private lenders have reverted to the traditional down payment rule of 10% or 20%. Housing experts agree that a high down payment is the best protection against default and foreclosure because it means the owner has something to lose by walking away. Meanwhile, at the FHA, the down payment requirement remains a mere 3.5%. Other policies—such as allowing the buyer to finance closing costs and use the homebuyer tax credit to cover costs—can drive the down payment to below 2%.

Then there is the booming refinancing program that Congress has approved to move into the FHA hundreds of thousands of borrowers who can’t pay their mortgage, including many with subprime and other exotic loans. HUD just announced that starting this week the FHA will refinance troubled mortgages by reducing up to 30% of the principal under the Home Affordable Modification Program. This program is intended to reduce foreclosures, but someone has to pick up the multibillion-dollar cost of the 30% loan forgiveness. That will be taxpayers.

In some cases, these owners are so overdue in their payments, and housing prices have fallen so dramatically, that the borrowers have a negative 25% equity in the home and they are still eligible for an FHA refi. We also know from other government and private loan modification programs that a borrower who has defaulted on the mortgage once is at very high risk (25%-50%) of defaulting again.

All of which means that the FHA and Ginnie Mae could well be the next Fannie and Freddie. While Fan and Fred carried “implicit” federal guarantees, the FHA and Ginnie carry the explicit full faith and credit of the U.S. government.

We’ve long argued that Congress has a fiduciary duty to secure the safety and soundness of FHA through common sense reforms. Eliminate the 100% guarantee on FHA loans, so lenders have a greater financial incentive to insure the soundness of the loan; adopt the private sector convention of a 10% down payment, which would reduce foreclosures; and stop putting subprime loans that should have never been made in the first place on the federal balance sheet.

The housing lobby, which gets rich off FHA insurance, has long blocked these due-diligence reforms, saying there’s no threat to taxpayers. That’s what they also said about Fan and Fred—$400 billion ago.

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