FHA Needs Taxpayer Money
Echoes of the Housing Crisis
Since its founding in 1934, the Federal Housing Administration had managed to run itself very successfully, providing home mortgage insurance to protect banks from mortgage defaults. It had performed so well, in fact, that it is the only government agency to be completely self-sufficient and self-funded.
Until now. For the first time in its 79 years, the FHA needs a taxpayer bailout estimated at $1 billion. It looks like the 2008 housing crisis is still claiming victims these five years later.
What went wrong? Has the FHA deviated from its original mandate? And will a projected slowing of the housing market preclude the FHA’s recovery?
Deviating into Subprime
The Federal Housing Administration’s primary business activity has always been selling insurance on home mortgages. It was structured in the midst of the Great Depression of the 1930s to take mortgage risk off of the banks, which were losing money as more and more home owners were failing to make their mortgage payments.
Although it has always been completely self-funded by the premiums from the insurance it sells, the agency has the government’s guarantee of emergency funding should it ever be required. This guarantee contributed a great deal to helping America out of its two severest housing crises of the 1930s and 2008.
Certain permissions have allowed the FHA to operate a little differently than private home mortgage insurers. The required down payment is extremely small at just 3.5%. While private insurers charge higher premiums on lower credit scores, the FHA charges the same premium across all credit ratings. And where private insurance annual premiums can reach as much as 5% for those with the poorest credit, the FHA’s yearly premiums are capped at 1.15%.
Such low rates together with the government guarantee have boosted the FHA’s share of insured mortgages to over one-third of the market, currently insuring over 5 million single family mortgages and over 13,000 multifamily properties.
Yet the FHA has been slowly shifting into a dangerous segment of the mortgage market – the high-risk subprime sector. As a result, losses of a staggering $943 million are expected for the fiscal year ending this September 30th, which will be automatically covered by the U.S. Treasury.
“Over the years, the FHA has strayed far from its original mission,” Texas Republican Representative and leader of the House Financial Services Committee, Jeb Hensarling, criticized in an e-mail statement obtained by Bloomberg. “It has become the nation’s largest subprime lender.”
Authoring a bill to get the FHA out of the sub-prime market, Hensarling urges, “It's time to return the FHA to its traditional mission of helping first-time home buyers and those with low and moderate incomes,” cites the Wall Street Journal.
Caught-Up in the Frenzy
The FHA’s risky activity began well before the housing market collapsed in 2008. As early as 2005, in an effort to capitalize on the housing boom, the agency increased the amount of cash borrowers could take out of their homes through “cash-out” refinances – essentially topping up mortgages and refunding equity.
Then, at the height of the buying frenzy from 2006 to 2008, the agency took on more and more mortgages made on loosening terms. Officials are still “pursuing a series of settlements over improper loan-origination practices with large banks,” the Wall Street Journal reports.
Another errant practice – which the FHA disliked from the start, and was finally able to stop in 2008 by appealing to Congress – was allowing non-profit organizations to “gift” the down payment requirement to home buyers on the condition they be repaid later without interest, yet for a registration fee. Since those down payments belonged to the non-profits and not to the home buyers, the FHA had no claim to those down payments when homes foreclosed, increasing the agency’s losses all the more.
Finally, in 2009, Congress increased the borrowing limits on reverse mortgages, which has ultimately resulted in the FHA sending more money out than it has taken in. The program’s cost – which started with $250 million of funding from the U.S. Treasury in 2010 – has ballooned to $5.2 billion in outflows this year. In the meantime, the surplus from its core mortgage insurance activity this fiscal year was only $4.3 billion.
Hence the $1 billion shortfall, which the Treasury is expected to cover next week.
Too Little, Too Late?
In an effort to close its budget gap and cover losses from all those insurance claims it had to pay out on homes foreclosed since 2008, the FHA has raised its premiums on new and existing mortgage policies. The recent rise in home prices has also helped, since premiums are based on the value of the mortgages.
More hope is seen in a lower number of mortgage delinquencies, which dropped by 12% from a year earlier. New foreclosures are also down, while recoveries on defaulted loans are up.
It is thus believed that the $1 billion provision will be just a one-time emergency rescue, with profitability restored by fiscal year 2014. But is a return to profitability after just one year realistic?
Yesterday’s National Association of Realtors pending home sales report for August showed a drop of 1.6% over July, meaning fewer homes are in the paperwork process of being purchased. Even though closed home sales were up in August, the NAR is calling it a “last hurrah,” since fewer home purchases in the pipeline today will result in fewer closed sales in future months.
“Sharply rising mortgage interest rates in the spring motivated buyers to make purchase decisions, culminating in a 6½-year peak for sales that were finalized last month,” Lawrence Yun, chief economist for NAR, explained to CNBC. “Moving forward, we expect lower levels of existing home sales, but tight inventory in many markets will continue to push up home prices in the months ahead.”
A cooling housing market could seriously hurt an already ailing Federal Housing Administration. Its recent raising of premiums has backfired, driving potential customers away as sales volumes dropped by 4% over the past year.
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Mortgage Backers Stretched to Their Limits
As a sign that the entire mortgage lending industry is still much too overstretched and almost buckling under its obligations, the Federal Housing Finance Agency – which oversees the government sponsored mortgage backers Freddy Mac and Fannie Mae – is attempting to reduce the maximum limits of the mortgages it will back.
Gary Thomas, the president of the National Association of Realtors, wrote in a memo cited by the Wall Street Journal, “An arbitrary reduction in existing limits, in the hope it will encourage more private sector lending, is a social policy experiment that risks dampening or reversing the ongoing recovery in the housing market and the economy as a whole.”
Thomas also rebukes the FHFA for raising the guarantee fees they charge banks. While the higher fees are intended to lower the appeal of government-sponsored loans and thereby draw more private lenders into the space, Thomas argues that the fees are simply passed on to the home buyers, adding to their mortgage burden.
If the housing market really is going to slow going forward – especially in the face of rising mortgage rates, which will only climb higher as the Federal Reserve finally begins reducing its monthly bond purchases by the end of this year – it is difficult to see how Freddy Mac and Fannie Mae can justify raising fees and lowering mortgage limits, let alone how the FHA can return to profitability within just one year.
It is too complex a fix to be remedied so soon nor to be handled aggressively, so cautioned Jim Parrott, a former housing adviser in the Obama White House, to the Wall Street Journal:
“You are solving a problem caused by overly loose standards on loans made six or seven years ago in an environment in which lending is already extremely tight...If you are too aggressive, you threaten to choke off the very lending needed to return the market—and with it the FHA—to greater health.”
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