Liberally prudent or imprudently liberal? Part 2, how we’ll get out of it
By: David A. Smith
[Continued from yesterday's Part 1].
Yesterday’s post dismantled a slightly fear-mongering Wall Street Journal suggesting that FHA’s net worth would fall below the statutorily mandated 2%, and if so, that FHA would need a ‘bailout.’ In fact it does seem that FHA’s portfolio is under stress, with delinquencies up from 5.4% to 7.8%, and that this will bring its net worth, last year a little over 3% of portfolio, down to or just under the target.
Steering between the capital-reserve pylons
Even though that under-capitalization will be no more than an accounting entry – unlimited credit does have its little advantages, does it not? – it signals a larger challenge, and one that needs addressing:
Critics have said the FHA, which has never had a chief risk officer, isn’t able to manage such a large portfolio in an unstable market.
With the FHA’s entire balance sheet – loans plus insurance commitments – at risk, the portfolio’s health is of critical interest to the nation. Against that, FHA’s information systems and its risk-management policies have been archaic. Add this to the list of major initiatives to be undertaken soonest – but in the meantime, keep lending on the successful programs, and shut down the risky or rotten ones – some of them foisted upon it by Congress.
Policymakers have used the FHA to stabilize the housing market by pushing it to offer credit with far easier terms than that offered by most private lenders. For example, it will back loans with down payments as low as 3.5%.
Last year, the agency ended a program [Nehemiah – Ed.] that allowed sellers to fund down payments.
That is fantastic news; I’m chagrined to have missed it. As I wrote two years ago, in 3% altruistic, it was little more than a transparent scam:
No, I’m truly substantial
Do the non-profits act as surrogates for the buyer, making sure prices are held down?
Sellers have tried to recover the cost of the fee they pay nonprofits by raising the price of the house an average of 3%, a 2005 study [text version here -- Ed.] by Congress’s nonpartisan Government Accountability Office found [also referenced here -- Ed.].
So let’s keep score here:
· Buyers use FHA-insured financing for 97% of the purchase price.
· Even though there is a 3% down payment, buyers do not pay it themselves. Independent non-profits give them the money.
· Non-profits get the money from property sellers.
· Sellers also pay the non-profits a processing fee.
· Property sellers raise prices by 3%.
In a cruder world, what these particular non-profits are doing might be called ‘procuring.’ In such a procurement, two entities get screwed:
What happens to those receiving a procurement
1. The buyers get screwed.
The higher prices contribute to the increase in foreclosures by buyers who have no equity in the homes, the GAO found.
2. The Federal government (that’s us taxpayers) gets screwed.
The programs are “a contributing factor of increased risk in our portfolio’ of loans, HUD spokesman Lemar Wooley said in an e-mail.
More than 100,000 low- and moderate-income consumers bought homes using such programs last year. The percentage of foreclosures on these homes is more than double that on other loans sponsored by the Federal Housing Administration, according to agency audits.
I’ll rebuild the temple if you give me 97% non-recourse financing and a 3% gift
HUD spent a year trying to shut the Nehemiah program down. Congress – including some members now in the leadership – fought it. Finally HUD prevailed:
While that program accounts for around 11% of the FHA’s loan book, it has generated 22% all loans that are seriously delinquent or in foreclosure.
At least, with Nehemiah gone, we’ve eliminated the riskiest program. Now we’re just dealing with normal recessionary risks:
Much of the FHA’s risk comes from its growing exposure to the broader economic downturn. The FHA is particularly sensitive to home-price declines because of the small down payments it will accept, which can quickly become wiped out by a fall in home values.
Higher risk is an intrinsic feature of highly levered hard debt.
FHA was here
“The size of their footprint in the mortgage market is so large that it exposes the FHA to economic risk, even if the products are performing well,” says Howard Glaser, a mortgage consultant and former HUD official.
True, but against that, FHA has national geographic diversification:
Resulting FHA losses are offset by premiums paid by borrowers.
FHA can also calibrate its insurance premiums up and down; that gives it a means of generating profits so long as the economy isn’t in continuous decline.
The FHA’s total assets have increased to around $31 billion, up from $27 billion one year ago.
Assets are loans. Insurance-in-force isn’t shown as a liability; only the net present value of the expected loss from that insurance makes it to the balance sheet, to be offset by the expected net present value of the insurance premiums.
The pending review, however, accounts for projected losses over 30 years. That put the estimated economic value of the fund at $12.9 billion last year, or around 3% of all FHA-backed loans.
No, really, I’ve got plenty of reserves
That’s on the $420 billion figure from a year ago. With a $624 billion base, the capital ratio will automatically be skinnier, except to the extent of new insurance fees (usually 1.0% up front) and ongoing insurance profits (net of writedowns and losses).
Before the boom, the FHA wasn’t a big player in the housing business because it didn’t follow private lenders in loosening its standards. Borrowers had to fully document incomes –
How novel.
– and insured loans were capped at $362,000.
Capping loans was less a risk-limitation move than an anti-competitive one. FHA legislative opponents argued, with some merit, that if the advantage of allowing the Federal government to provide mortgage insurance on loans with higher leverage were applied to all loans, FHA would crowd out conventional lenders. They argued, quite sensibly, that such advantages should be targeted mainly toward affordable housing, which could be efficiently controlled by limiting loan sizes.
Congress increased those limits last year to as high as $729,750 in the most expensive markets.
A conscious crowding-out move, and thought to be temporary.
In August, the FHA and the U.S. Department of Veterans Affairs backed 40% of loans for all home sales.
Fannie and Freddie buying nearly all of the rest.
While most private lenders have raised lending standards and now require minimum 20% down payments, the share of borrowers who are able to make down payments of less than 10% hasn’t changed in the last two years, largely because of the FHA, says Mr. Pinto, the former credit officer at Fannie Mae.
The government, in short, is backstopping basically the entire residential mortgage market.
Open heart surgery on our residential financial system
Officials said as recently as May that they didn’t expect to fall below the 2% limit, but home-price declines have exceeded those used to model their expected losses. Given the pace of those declines, “there is no way they will make the 2%” if the current study follows last year’s methodology, says Mr. Lawler.
If so, Congress will have to do something – which could be as feckless as giving FHA a capital waiver. Probably will be as feckless as that …
The FHA says it has seen loan quality improve in recent months, including an increase in average credit scores and a decline in loans that were one month delinquent. The agency expects to make $1.4 billion on loans it will insure for the fiscal year that begins in October.
All things considered, this is a positive record.
In 2005, the FHA loosened its maximum loan-to-value limit on cash-out refinancing to 95%, from 85%.
Catch that word ‘cash-out’? FHA distinguishes between refinancing to reduce costs, or to improve property, and refinancing to extract equity, the theory being that an owner with hard equity in the property is less likely to default than identical owner with an identical loan and less of his or her own money at stake.
The agency moved that limit back to 85% earlier this year.
More prudence.
Reflect carefully before you act, Prudence
HUD Secretary Shaun Donovan said in June the FHA would be ‘more than likely to stay out of a broader need for any taxpayer funding.’
Since we’ve already guaranteed all its lending, that’s not terribly profound, but what else could he say?
Keep smiling!
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