The Housing Chronicles Blog: Is the FHA up to the task of rewriting mortgages?

Thursday, April 10, 2008

Is the FHA up to the task of rewriting mortgages?

Over the last 10-15 years, FHA loans became scarce because private lenders were offering much more flexible terms than what FHA requires (i.e., 3% down, stricter debt limits, fixed-rate mortgages, etc.). Now that the FHA is being floated as the most promising candidate to re-write those loans at risk of foreclosure, however, some people are sending up warning flags that the federal government has completely thought this through. From a story:

At the center of all of Washington's efforts to rescue the battered housing markets is the formerly obscure Federal Housing Administration.

But it's not clear whether the agency is up to the task or whether it will need a taxpayer-funded rescue of its own.

The agency currently backs $385 billion in mortgage loans, but that figure could double in the coming year if some of leading proposals in the White House and Congress go through...

Even FHA officials concede they don't know if the agency can handle the increased role. The FHA has been a small lifeboat helping a select group of home buyers, but it could be overwhelmed by the rush of new borrowers trying to climb aboard...

The FHA is a New Deal-era agency that helped create the modern mortgage market. The FHA program is intended for mortgage borrowers with weak credit or little or no cash, who may not be able to otherwise get an affordable mortgage.

Borrowers get FHA loans from private lenders, just as they would any other mortgage. FHA offers insurance to cover lenders if those borrowers, who pay a small insurance premium to the FHA every month, default on the loan. The FHA uses those premiums to cover the lender in the event of foreclosure.

During the housing boom in recent years, FHA's share of mortgages fell to only 7% of mortgage loans outstanding in 2007. Now that the mortgage market has collapsed, the FHA is suddenly the only choice for many borrowers and lenders....

About 150,000 borrowers have refinanced under a new program called FHASecure in the past six months. Launched in September, this program is aimed at subprime borrowers facing steep mortgage rate resets that they couldn't afford. That volume compares to the total of 425,000 loans the FHA backed in its previous fiscal year.

What's more, the loan limit on FHA loans was increased in March, which will further expand FHA's portfolio...

But Federal Deposit Insurance Corp. Chairman Sheila Bair acknowledged the risks inherent to the Frank plan in her testimony before Congress on Wednesday, saying no one knows if FHA premiums will be able to cover the increased risk of FHA's expanded mission.

"Losses that exceed the funds available in the reserve would have to be covered by taxpayers," she warned.

Those concerns were echoed by FHA Commissioner Brian Montgomery during the same hearing.

"The FHA should not be forced legislatively to compromise its fundamental criteria at the future expense of the taxpayer," he said. "The FHA currently is self-sustaining. As you know, few government programs can claim the same. We do not want to cross that line, particularly at a time when we are most needed."

The agency began backing increasingly risky loans even before this crisis hit. The cost of potentially bad loans insured by the FHA was estimated at $7.5 billion as of Sept. 30, up from $3 billion a year earlier and just $1.9 billion a year before that....

Some experts back the idea of making the FHA more aggressive, even if it will eventually require a taxpayer bailout.

"We sometimes refer to these proposals as stealth bailouts," said Seiberg, "because they don't necessarily require money today, but they may require funds down the road."

Seiberg and other economists agree that there's a risk of a taxpayer housing bailout no matter what FHA does.

"Congress may decide that it wants FHA to take more risk because it doesn't require [the government] to appropriate money up front, and it may not require money on the backside if we're able to turn this crisis around," said Seiberg.

"But if you can't turn this crisis around, if home price declines continue for two or three years, all lenders will be in trouble, and so will the FHA."

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