FHA Reserves Below Minimum

The FHA's capital-reserve fund fell to $3.6 billion as of September 30th, leaving reserves at just 0.53% of the $685 billion in total loans insured by the FHA. This is far below the 2% requirement level that the FHA said it had breached months ago. The Secretary of HUD, Shaun Donovan, downplayed the FHA's problems and claims that the FHA won't need a federal subsidy except under the most severe economic scenarios. Like 10% unemployment, maybe? The problem is that projected capital losses in 2009 were worse than the most pessimistic assumptions from last year's review, so really, I'm not sure we should trust Mr. Donovan's reassurances of the agency's solvency.

Apparently, this is what happens when the government tries to prop up a mortgage market that was initially propelled aloft by private no-downpayment mortgages to people with terrible credit. While FHA-insured mortgages require small downpayments, they are still offered to borrowers with lousy credit. The only difference between FHAs and Alt-As is that FHA mortgages have very low fixed rate mortgages, so there is no surprise doubling or tripling of payments a few years down the road. Unfortunately, default rates on FHA insured mortgages are surging, proving that minimal downpayment mortgages to borrowers with terrible credit are extremely high risk, even with a fixed rate. The '08 vintage already has a 15% delinquency rate, handily outpacing earlier years' vintages. Furthermore, the volume of loans insured by the FHA jumped 75% in the 2009 fiscal year to more than a quarter of the mortgage market, from a mere 2% in 2006. During the second quarter the FHA backed nearly half of all mortgages made to first-time home buyers. No matter how much HUD tries to downplay it, it is inevitable that we will be bailing out the FHA too. So, sure the housing market is stabilizing. But at what cost to the rest of us?

Financial Headlines 9/18/2009

A bunch of non-news news in the headlines today:

• The FHA's reserves are set to drop below the minimum level of 2% set by Congress. Is this really news? Default rates on FHA-backed mortgage loans have been sky-rocketing. It's what happens when you allow borrowers with only 3.5% of a downpayment to purchase homes, not all of these folks will be reliable credits. But fear not, the FHA will get its bailout, just like every other housing-related agency.
• Officials are warning that option ARM mortgages are set to explode. Option ARMs were designed to explode. So why are we reporting this as news? The first time I read about an option ARM in 2005, I thought "Geez, these things will explode in a few years when borrowers have to repay principal plus all of that extra interest that's been accruing." I guess the news here is officials have finally taken notice, which means its going to happen tomorrow and it's too late to do anything about it.
• The WSJ reports that bankers are facing "sweeping curbs on pay." The article follows up with a very vague description of how the Fed is going to be able to reject any compensation policies it believes encourages bank employees to take excessive risk. Mind you, the Fed's recent ridiculously easy money policies were designed so that a monkey could make money this past year if it worked at a bank, at the expense of our entire nation, so you can imagine they're really going to crack down on comp. The article should've been entitled "Bankers facing yet more bonuses, and nobody is going to do anything about it."
• Vikram Pandit thinks $100 million might be a bit much to pay to any one employee. But he's probably just bitter because he's only working for $1 this year.
• Speaking of comp, the WSJ has a very interesting article about how the nation's really smart graduates, engineers from MIT and the like, are steering away from finance to find more fulfilling work. The article shows how much the pay incentives on Wall Street led to a misallocation of our nation's smartest minds away from lower paying jobs like engineering and medicine, into careers trading and selling derivatives. The trend is apparently moving in the opposite direction now.

FHA Working Hard to Sell Some Condos

What to do about the glut of new condo developments around the country sitting half-empty, waiting for buyers to save them from the inevitability of foreclosure proceedings?  Rest assured that some sort of government bailout is the answer.  If a developer can get a building approved by FHA, then potential buyers can get a mortgage from an FHA-approved lender with only 3.5% down.  Tack on the $8,000 first time homebuyer credit and you can practically get a condo for free.  For a building to be approved by FHA, it must be 51% sold, so the developers have to do a bit of work to get to the threshold, but then, the condos should practically sell themselves.  Congress helped the cause by boosting FHA loan limits from $417,000 to $729,750, making virtually all condos eligible for FHA loan guarantees, except for all of the luxury buildings in Manhattan that are attempting to sell buildings full of units for $5 million a pop (I wish them luck.)  With Fannie and Freddie both tightening condo lending standards by requiring 70% of the units in the building to be sold, FHA is actually considering LOWERING its standards for approval, out of concern that the condo market is going to implode if somebody doesn't stop the madness.  I mean, really, how are developers supposed to sell all of this condo inventory that was conceived and built during an unsustainable condo-flipping frenzy at prices that nobody can or is willing to pay if the government isn't going to offer to insure no down-payment loans?  

The good news is that 93,000 condo units are scheduled for completion in 2009, a 28% increase over last year, according to Reis Inc.  So that should really help clear up the inventory problem.  Even better news is that nearly one-third of all first mortgages are now being originated through FHA, up from about 2% in 2006, when all of those highly successful subprime lenders, none of whom remain, were the leaders in the no down-payment mortgage game.  Best news of all, of course, is that delinquencies on FHA-backed loans rose to 7.5% in February from 6.2% a year earlier.  With unemployment rising and housing prices falling, delinquency rates will no doubt surge higher.

To be honest, at least FHA-backed loans are simple, fixed-rate mortgages that most people can comprehend.  They might not understand the math, but they can handle having to pay the same amount of money every month for the next 30 years.  We won't see the same leap in defaults once borrower's payments triple when their negative-am loans recast, because the payments won't change over time.  So hopefully the FHA program will help some who otherwise wouldn't have been able to purchase a home.  But let's hope that when the next housing bubble rolls around they don't screw it up with a cash-out refi.   

FHA-Backed Lenders: Terrible Underwriters

Remember when the FHA was supposed to solve the "credit crunch" by providing much-needed liquidity to borrowers who could no longer get mortgages?  It turns out that FHA-backed lenders are just as bad at mortgage underwriting as the worst of the subprime lenders.  The Washington Post reports that the number of borrowers who failed to make more than a single payment before defaulting on an FHA-backed mortgage nearly tripled, far outpacing the agency's overall growth in new loans.  Industry experts attribute the jump to the weak economy, lax scrutiny of prospective borrowers and most notably, foul play among unscrupulous lenders.  More than 9,200 of the loans insured by the FHA in the past two years have gone into default after no or only one payment.  Of course, the overall default rate on FHA loans is accelerating rapidly too, but not as dramatically as the rate of instant defaults.

But wait, the story only gets better!  The agency's share of the mortgage market is up from 2% three years ago to nearly a third of the mortgages now made.  Under the FHA's rules, if the borrower makes no more than one payment before defaulting there's a presumption of fraud that must be investigated by the lender.  However, the FHA's fraud unit which used to investigate abusive lending practices was dismantled in 2003 as the FHA's business dwindled (presumably it lost business to all of the now-defunct subprime lenders.)  Furthermore, the FHA office responsible for approving new lenders has not expanded despite the fact that the number of active lenders has doubled to 2,300 in the past two years.  Although lenders that are deemed abusive can be kicked out of the program, the FHA does not appear to be adequately staffed to police all of its lenders.  

The article gives a depressing example of a condo project in West Palm Beach, Florida where a 28 unit apartment building was converted to condos three years ago.  The complex had the same owner as an FHA-approved mortgage company that pushed no-money-down, no-closing-cost loans to prospective buyers.  Now, 80% of the loans on the project have defaulted, a dozen after no payment or one.  This particular lender, called Great Country, has the highest default rate of any FHA lender, brace yourself - a default rate of 64%.  Seriously, click on the link if you think that was a typo.  64% of all loans have gone bad!  The article did not mention that Great Country has been kicked out of the FHA program so I'm assuming it is still a lender!  With the FHA taking all of the risk of the mortgage defaults, it's possible to stay in business with that kind of track record.  I, for one, am hoping that Barney Frank reads this article and decides to beef up fraud investigations at the FHA or "Hope For Homeowners" will turn into "Weep the Taxpayers."