Friday, September 04, 2009

WSJ: Loan Losses Spark Concern Over FHA

As if this isn't familiar. Last year it was sub-prime, wall street banks and Fannie/Freddie - after they all collapsed the FHA stepped in to continue making loans that don't make a lot of sense. Make no mistake, the FHA lending has help prevent an even greater collapse in housing, but at what price? The FHA now even makes loans up to 125% of the house's value and to people who have less than perfect credit...sound familiar?

"They're 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."

What happens if we end up having to bail out the FHA? We're already about to bailout the FDIC. Perhaps we should stop naming financial entities that have some government connection with names that start with "F".

"Resulting FHA losses are offset by premiums paid by borrowers. Federal law says the FHA must maintain, after expected losses, reserves equal to at least 2% of the loans insured by the agency. The ratio last year was around 3%, down from 6.4% in 2007."

Let me get this straight, the FHA can still operate successfully with reserves as low as 2% and is expected to hit that level soon and that is just fine? Wouldn't that indicate a leverage ratio of 50 times? Doesn't that sound like Bear Stearns or Lehman? The difference is government is not subject to the same accounting rules as private industry (though these days it seems like private industry isn't subject to their own accounting rules) and thus there would be no "run on the FHA" that could lead to a panic. However at some point somebody responsible has to step in and cut off the credit valve and stop making loans to borrowers who represent poor risks.

Would you make a loan of 125% of the value of a home to somebody who was behind on their monthly payments? Of course not, but guess what - you are. The FHA is a government (New-Deal Era) entity that is supposed to be self-insured via fees that borrowers pay, however loose credit guidelines will ensure that those fees are not nearly enough to cover the coming losses. No worries, the taxpayers will just bail the FHA out.

The housing recovery that has received so much press has been built on FHA loans, what happens if the FHA fails? Can it fail? These are questions that need to be asked and these lending practices must be stopped. If there was a sudden pullback in FHA financing, housing would drop substantially (it may still fall given the huge number of foreclosures on the way).

Scott Dauenhauer CFP, MSFP, AIF