Thursday, October 1, 2009

The FHA and Subprime America: House on Fire!

The Federal Housing Administration, the longtime self-funded mortgage arm of government insurance programs, is now taking a number and waiting in turn for its taxpayer-financed government bailout. Get out your checkbooks.

Created in 1934 the FHA’s purpose was to stimulate mortgage underwriting by insuring mortgages for risk-averse banks and encouraging a new wave of home-loans. The program worked during the depression and continued to work even as an increasingly privatized mortgage industry developed ever-more creative loan packaging to insure sub-prime mortgages. Promoted by politicians the FHA evolved in the 21st century to underwrite home loans for low and moderate-income buyers whose shaky credit would otherwise lock them out of the housing market. Whether or not you agree that every low-income American with Swiss-cheese credit deserves to own his or her own home is beside the point. As a taxpayer, and therefore a stakeholder in the FHA, you could rest easy knowing that “the FHA is the only government agency that operates entirely from its self-generated income and costs the taxpayers nothing.”(1) But that was in 2006, when the FHA insured just 2.7% of the single-family mortgage market. By the second quarter of 2009 its market share was 23% and self-funding was as viable as General Motors’ Hummer.

Led by the government’s attempt to stem the housing collapse this 10-fold increase in market share was due in large part to the Housing and Economic Recovery Act of 2008 which then-President Bush signed into law on July 29, 2008. Sponsored by Reps. Barney Frank (D-Massachusetts) and Maxine Waters (D-California) the bill included new authority for FHA to insure up to $300 billion of troubled mortgages. FHA is working overtime to accomplish the task.

FHA loans are packaged by mortgage bankers and sold in pools of Ginnie Maes then distributed by Wall Street dealers to investors either as Mortgage Backed Securities (MBS’s) or as Collateralized Debt Obligations (CDO’s). Ginnie Maes carry the full faith and credit guarantee of the U. S. Treasury. Their losses are covered by the FHA. So Ginnie Mae, a full faith and credit issuer of the government is on track for a record issuance of securities and the taxpayer’s backstop is the FHA. On September 10, 2009, Ginnie Mae announced it had issued $45 billion of mortgage backed securities in August alone, the fifth consecutive month of record issuance.(2)

Swamped with increasing delinquencies the FHA is “probably going to need a bailout at some point because they’re making loans in a riskier environment,” says Edward Pinto, a mortgage-industry consultant and former chief credit officer at Fannie Mae. “…I’ve never seen an entity successfully outrun a situation like this.” The problem stems from the FHA’s cash flows. As an insurance company, the FHA earns a percentage of loan payments on its insured mortgages. When its market share was in the single digits and home-owners were actually paying their bills, things worked well. But FHA delinquencies have increased from 5.4% a year ago to 7.8% today and accelerating default rates are rapidly eating through the FHA’s reserves. David Stevens, the FHA Commissioner, told Congress that the agency will fall below the 2% minimum reserve required in its charter, down from a 6.7% reserve in 2007.(3) In 2007 FHA earned $1.521 billion and gross costs (government speak for expenses) were $3.89 billion for a net cost of $2.369 billion, the first loss in 75 years of operation. In 2008 revenue was down slightly at $1.471 billion and costs soared nearly tripled to $11.378 billion for a net cost of $9.9 billion! (4)

And how is the program created in 2008 to help troubled borrowers working? On Wednesday the Office of the Controller of the Currency and the Office of Thrift Supervision reported re-default rates on troubled borrowers is running in excess of 50%.

With 5 months of record issuance behind us, and ostensibly many more to come, why isn’t the FHA on track for record profits? The FHA funds itself by receiving an ongoing percentage of the interest payment made by the borrower for insuring each mortgage. But now delinquencies are increasing faster than even the government can issue debt. Revenue on the portfolio is 37.5 basis points or approximately 1/3 of 1 percent. At the end of Fiscal Year 2008 the outstanding portfolio was $534 billion generating roughly $2 billion in revenue and defaulting at a rate of almost 8%. At September 30, 2008 the FHA surplus reserve fund was $12.9 billion. That number is expected to fall below $10 billion by September 30, 2009, the end of this fiscal year, for a net decline of $4.7 billion dollars. This gives the FHA a leverage ratio of 54:1 nearing twice the highest leverage of the major banks prior to the 2008 crash on a portfolio with only 3.5% down payment. Do the math.

And this is a drop in the bucket compared to our next discussion: Fannie Mae and Freddie Mac. With the combined entities of FHA, Fannie Mae and Freddie Mac, the American taxpayer is now guaranteeing 90% of all the home mortgages made in America. And then the Federal Reserve is purchasing those loans so we are first guaranteeing the loans then buying them! Huh?

4. 2008 Department of Housing and Urban Development Annual Performance and Accountability Report (Available on request)


  1. Love the blog Paul. The posts about GM are particuarly poignent for me, having lived in the Detroit area for 14 years. (Wife is a native Michigander, her dad a GM engineer retired. Worked in Flint, the ghost town. I did my grad work at Wayne State in D) Sad to see what has happened to an American institution, and the state. You're on my blog roll!

  2. So what are these unfunded liabilities? Everyone knows housing is in the toliet but I was looking for what the title iomplied.