Affordable Housing Institute : US

By: David A. Smith

 

[Continued from yesterday's in Part 1.]

 

In yesterday’s post, we compared the public pronouncements of two enormous governmental lenders whose financial viabiltiya nd liquidity are in question: FHA in the US, from the New York Times (in plain text) and the World Bank, from the UK Telegraph (in indigo palatino).  The World Bank, which wants more capital from its member nations, says it’s not broke but illiquid, while the FHA told Congress that even though it can never be illiquid (because it’s guaranteed by Treasury), it’s not broke.

 

 

The hearings on Thursday came on the same day that the federal agency charged with overseeing Fannie Mae and Freddie Mac provided a somber assessment of those giants’ health. In the year since the government stepped in to rescue them, the companies have taken $96 billion from the Treasury, and may need more.

 

Since the bottom fell out of the mortgage market, the FHA has assumed a crucial role in the nation’s housing market. Created in 1934 to help lower-income and first-time buyers purchase homes, the agency now insures roughly 5.4 million single-family home mortgages, with a combined value of $675 billion.

 

While those figures are well short of what Fannie and Freddie have been financing, they represent a large and rapidly rising inventory.

 

 “It appears destined for a taxpayer bailout in the next 24 to 36 months,” Edward Pinto, a former Fannie Mae executive, said in testimony prepared for the hearing. Mr. Pinto, who was the chief credit officer from 1987 to 1989 for Fannie Mae –

 

I can’t find out much about Edward Pinto.  His December, 2008 testimony describes his background this way: “real estate financial services consultant … left the company in 1989 and since then I have specialized in providing mortgage finance related consulting services.  Since leaving Fannie Mae, I have followed the GSEs closely.”  He thinks CRA is toxic – and I don’t.  Color me cautious in accepting his opinion as gospel.

 

I suspect no one … and everyone

 

– went further than most housing analysts and predicted that FHA losses would more than wipe out the agency’s $30 billion of cash reserves.

 

Mr. Pinto seems to be dining out on these gloomy predictions, which to be sure doesn’t necessarily make him wrong.

 

The troubled loans are nevertheless weighing on the agency’s capital reserve fund, which has fallen to below its Congressionally mandated minimum of 2%, from over 6% two years ago.

 

The optimism expressed by Mr. Stevens, the FHA commissioner, places him at odds not only with some outside experts but with Kenneth Donohue, the inspector general of the Housing and Urban Development Department, who is also FHA’s watchdog. Mr. Donohue said the drop in reserves was “a flashing red light” that the agency was not taking seriously enough.

 

“It might be we’ll get ourselves out of this and that everything will be fine, but I don’t paint that rosy a picture,” Mr. Donohue said. “They’re banking on the fact that the economy will continue to improve, that the housing market will begin to sustain itself.”

 

We are in unknown territory; all actions involve risk. 

 

Anywhere you go, hic sunt dracones

 

Maybe I’m parsing too carefully, but Mr. Donohue’s warnings – entirely appropriate ones, he’s the Inspector General – are not the same as claiming that FHA “appears destined for a taxpayer bailout.” 

 

Rather, he’s sounding a warning similar to Mr. Zoellick’s World Bank warning:

 

Mr Zoellick, speaking at the opening of the IMF and World Bank annual meetings in Istanbul, said the Bank needed a capital increase of $3bn-$5bn, though others suspect the eventual need could be higher still.

 

The increased capital will represent hard equity that will provide the first-loss cushion for future lending.

 

Think of hard equity as the lender’s air bag

 

He said he hoped that its shareholders, including the UK and other leading nations, would decide on resources before its spring meeting next April.

 

Mr Zoellick said: “We recognise that all countries are under budgetary strain and it is not an easy time to be asking for these things”. He said that a shortfall of cash for the IFC was a cause for particular concern, Mr Zoellick added, “because one of the issues in this recovery is the hand-off from government stimulus programs to private-sector development.”

 

He’s reminding us of a point all too often forgotten: government should be a catalyst, stimulating first-mover activity on the bankable frontier, colonizing the space and then vacating it when it has been formed and stabilized.  Government must boldly go where no private market has gone before.

 

“To seek out new loans and new innovations”?

 

The World Bank intends to lever that $3-5 billion in new equity 95-97%:

 

Critically, the Bank’s three-year $100bn programme, committed to last year because of the virulence of the financial and economic crisis, is expected to fall short of the eventual demand from struggling economies. The majority of the money has been spent ensuring the survival of the most vulnerable nations.

 

If $3-5 billion of new equity will lever $100 billion in new lending, that’s a 3-5% ‘down payment.’ Oddly enough, that’s the same ratio at which FHA is now lending:

 

The government has stepped into the breach, facilitating loans with down payments as low as 3.5% and offering other incentives to stabilize the market. Real estate agents in some hard-hit areas say every single one of their clients is using the FHA.

 

Anyone with a PhD in Common Sense knows that the more hard equity a borrower has in the investment, the lower the default risk, both because of favorable loan-to-value ratios and because

people care more when they’ve put their own money in. 

 

“They’re counting their pennies, scraping up that three point five percent,” Bonni Malone of Prudential Americana in Las Vegas said. “Mostly they’re buying foreclosed homes from banks, although I had one client who bought from a guy that was dying. It’s turning around the market.”

 

Houses cost more than people can afford unless they borrow.  So the withdrawal of credit from real estate lending can easily collapse prices, and its replenishment can help stabilize them. 

 

You need a lot of green to keep the nation from sinking further into the red

 

The Depression was brought on in part because credit fled to the sidelines, starving businesses and homeowners of capital to enable them to keep their businesses open.  It’s why FHA was born in the Depression; why FDIC and FSLIC came out of the Depression; why, in short, the government entered the lending-liquidity business 75 years ago. 

 

One of the cards was labeled, FHA

 

While the government’s actions have helped avert full-scale economic disaster, there is growing concern that it might have doled out its favors with too generous a hand.

 

Many of the loans the FHA insured in 2007 and last year are now turning delinquent, agency officials acknowledge. The loans made in those two years are performing “far worse” than newer loans, dragging down the whole portfolio, Mr. Stevens of the FHA said in an interview.

 

This is unsurprising.  Older loans having been seasoned, they establish a performance history.  And if you lend into the teeth of a recession, as we now know FHA (and others) did, you have to brace for higher losses.

 

You want to lend into this?

 

How high can we afford?

 

The number of FHA mortgage holders in default is 410,916, up 76% from a year ago, when 232,864 were in default, according to agency data.

 

Anyone with an ounce of sense would be worried by these figures, not just the numbers but the spike in percentages:

 

Despite the agency’s attempt to outrun its fate by insuring ever-larger amounts of new loans [snip] — the current rate is over a billion dollars a day — 7.77% of the portfolio is in default, up from 5.6% a year ago.

 

Observe that the default rate is up only 40%, whereas the default numbers are up 76%, simply because FHA is insuring so many more loans.  In other words, it’s not quite as bad as the default numbers would suggest.

 

Meanwhile, statements like this don’t help, even making due allowance for Mr. Frank’s propensity to give the super-compressed response with the subject-to’s and qualifiers omitted:

 

If you misunderstood me, you forgot to hear the words I left unsaid

 

Barney Frank, the Massachusetts Democrat who is chairman of the House Financial Services Committee, said in an interview that the defaults were, in essence, worth it.

“I don’t think it’s a bad thing that the bad loans occurred,” he said. “It was an effort to keep prices from falling too fast. That’s a policy.”

 

He can’t have meant that the way it sounded (can he?).  Mr. Frank must have meant that if you are going to liberalize lending, so as to keep liquidity flowing and to prevent a credit-crunch asset collapse, you must accept that some bad loans occur.  The question, as I posed a month ago, is, how liberal is too liberal?

 

[HUD Inspector General Donohue] noted that if private lenders had raised their down payment requirements in the last two years, it raised the question, “what does the FHA think it is doing by asking only 3.5%?”

 

It thinks it’s taking a prudent risk because the private lenders have a liquidity crunch that compels them to tighten capital, whereas FHA does not.

 

As the number of loans has soared, random quality control checks have decreased sharply, FHA staff members say.  [Ah, the ultra-reliable 'unnamed sources. – Ed.]

 

Is FHA headed for a crackup?  Is the World Bank?  Nobody knows for sure, because prediction is very difficult, especially about the future.

 

The future, Wener, is uncertain

 

Mr. Donohue, the inspector general, cited numerous examples of organized fraud in testimony to Congress earlier this year.

 

“They need to stop taking bad loans in the door,” he said in an interview. “They’re taking on all this volume, they have to have very active underwriting standards.”

 

Nobody will argue with that.

 

“No man of sense could dispute that.”

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