When everyone else gets sick, even the healthy start having symptoms too.

Oh, I should never have gorged on those ‘07 and ‘08 loans

As one of only three stores left open, still selling single-family and multifamily long-term financing, the Federal Housing Administration – the GSE from the right side of the blanket, as it were, the one always acknowledged as part of the Federal government – is showing stresses in its portfolio of new loans.  As reported by The Washington Post:

The share of borrowers who are falling seriously behind on loans backed by the Federal Housing Administration jumped by more than a third in the past year, foreshadowing a crush of foreclosures that could further buffet an agency vital to the housing market’s recovery.

As I posted back in September, FHA’s loan losses will not ‘buffet’ the entity because it is a direct arm of the Federal government, and as such cannot go bankrupt independent of a Federal bankruptcy – and while sovereign bankruptcy is on the horizon for Dubai and Greece, we are not in that situation (thankfully) (yet).

About 9.1% of FHA borrowers had missed at least three payments as of December, up from 6.5% a year ago, the agency’s figures show.

Not only is a 9.1% serious delinquency rate high, that’s atop an already high 6.5% rate.  The homeownership arena is still hurting – now not because of declining property values, but rather because of the ongoing structural weakness that the so-called stimulus legislation has clearly done nothing to reverse.

Year-over-year delinquency rate change; it’s worse in the West

Although the FHA’s default rate has been climbing for months and eating into the agency’s cash, the latest figures show that the FHA’s woes are getting worse even as the housing market shows signs of improvement. The problems are rooted in FHA mortgages made in 2007 and 2008.

Loan defaults have an incubation/ contagion phase delay.  As we saw in the decade’s biggest invisible stories, during 2007 and 2008 originators like Countrywide offloaded swaths of their inventory onto long-term government players (like naive Fannie Mae).

Those loans are now maturing into their worst years because failures most often occur two to three years after a mortgage is made.

By now we know it’s regionalized: California/ Nevada, Florida, and the Upper Midwest

If the trend continues and the FHA’s cash reserves are exhausted, the federal government would automatically use taxpayer money to cover the losses –

Which I noted months ago:

The Federal Housing Administration, the original government lender and hence the precursor to Fannie Mae and Freddie Mac; as a forerunner, FHA’s government connection was and is more direct.  It’s an arm of HUD, hence its securities carry the full faith and credit of the United States, unlike its GSE heirs Fannie and Freddie, which borrowed money on the capital markets without direct Federal support.

[Uh, until recently.  – Ed.]

“It’s pronounced ‘feefa’ not ‘fiefdom’”

That means that unlike Fannie and Freddie, who are likely to return to a non-guaranteed state some day, the government is always exposed for the entire FHA portfolio.  And FHA has a further tool that Fannie and Freddie do not: in addition to making direct loan, it offers mortgage insurance. 

Now the piper may need to be paid:

– a first for the agency, which has always used the fees it charges borrowers to pay for its losses.

Uh – except for that Great Depression thing we had during 1934, when FHA was created.

And back then, we had much lower homeownership rates

As these loans from 2007 and 2008 go bad and clear off of the FHA’s books, agency officials said, losses are expected to taper off, aided by the housing market’s anticipated recovery and an influx of more creditworthy borrowers, who have flocked to the FHA’s home-buying program in the past year.

We thus have a race of sorts.  Which will mature first – the capitalized value of the new insurance premiums, or the recognized losses from the recent vintages?  Fortunately, because FHA is already owned by the Federal government, it’s more of an academic and economic-efficiency question than one of national consequences. 

Agency officials said they have cracked down on poorly performing lenders and announced higher qualifying fees for borrowers. On Monday, the agency projected that the fees should generate $5.8 billion in fiscal 2011 [Which ends 30 Sep 10 – Ed.], up from $2 billion this year.

That seems highly plausible.  With Fannie, Freddie, and FHA the only games in town, they are all gulping new market share.

Two whose patrimony was only recently acknowledged

One who always knew who was its mother and its father

That would fatten the FHA’s cash cushion, used to cover unexpected losses.

An exasperating imprecision – FHA has no banks accounts of its own, it draws from the Treasury as required.  A better formulation is that the incoming premiums will significantly increase FHA’s net worth, giving reassurance to the check-writers at Treasury.

The FHA does not make loans but insures lenders against losses. And claims have already spiked. The agency had to pay out on 47% more loans in October and November than in the corresponding period a year earlier, according to an FHA report.

Ouch!

Didn’t see that coming

The number of loans in foreclosure, including those that have not yet been billed to the agency, has also increased. They were up 26% in the last quarter from a year earlier.

Ouch.  Foreclosure, though, is simply a lagging indicator of claims, as claims as a lagging indicator of serious delinquencies.  Neither is an independent variable in itself.

Nice dependent variable

FHA Commissioner David H. Stevens, who joined the agency in July, flagged his agency’s troubles with the 2007 and 2008 loans in October, when he told a House panel that “rogue players on the margin” immediately migrated to the world of FHA lending after the subprime mortgage market collapsed.

Oh, you think?

I don’t like being linked to a phrase like ‘rogue player’

Their aggressive lending tactics attracted borrowers with unusually poor credit profiles to the FHA. “That clearly impacted the books of business in 2007 and 2008, and that performance data is showing up very clearly in today’s balance sheet,” Stevens said at the time.

Even so, at the time Mr. Stevens was optimistic, and no one was under any illusions about the essentiality of keeping FHA in business.  As I posted in October:                            

Would that elected officials and journalists could refrain from politicizing what should be bipartisan evaluations of entity performance and importance.

“FHA has stepped into the void left by the private market,” Representative Maxine Waters, Democrat from California, said at the hearing. “Let’s be clear; without FHA, there would be no mortgage market right now.”

Ms. Waters knows where she stands

Together with Fannie and Freddie, FHA is the credit backstop for about 80% of all US residential lending right now.  While it’s terrifying to think of that much lending being concentrated behind the government, it’s more terrifying to think of any one of the three stopping cold.

No more lending?

But [Stevens] acknowledged that some 20% of FHA loans insured last year — and as many as 24% of those from 2007 — faced serious problems including foreclosure, offering a preview of a forthcoming audit of the agency’s finances.

This shouldn’t be entirely surprising, recognizing that in 2008 FHA was the lender of last resort, and as we have chronicled, many of these refinancings were done hopefully.

“Let me simply state at the outset that based on current projections, absent any catastrophic home price decline, FHA will not need to ask Congress and the American taxpayer for extraordinary assistance — we will not need a bailout,” Mr. Stevens said in his testimony.

That is a direct and clear statement.  Let’s hope it’s true. 

If I’m wrong, strike me dead

Is Commissioner Stevens rethinking his view?

With  new facts, I have no choice but to rethink

Plunging home prices have exacerbated matters by leaving some FHA borrowers unable to sell or refinance their homes because they owe more than their homes are worth. Yet with unemployment running high, many borrowers can’t afford to keep up their payments.

Adding to the trouble was a now-defunct FHA program that enabled sellers to cover the down payments of buyers. This meant many borrowers had no skin in the game and were more likely to walk away at early signs of trouble.

In May, 2007, I first wrote about this scandalous program, lambasting it:

It’s sounding more and more like the buyer is merely a patsy, and the non-profits are acting as the sellers’ paid agent.   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:

In a cruder world, what the non-profits are doing might be called ‘procuring.’  In such a procurement, two entities get screwed: buyers and the Federal government (that’s us taxpayers).

This is for us taxpayers

By June, 2008, it was clear FHA was looking at $4.6 billion in losses, mostly from Nehemiah.  That number has now more than doubled:

The program resulted in excessive defaults before it was ended in late 2008, and it is projected to cost FHA an additional $10.5 billion in losses, Stevens said.

Every time I revisit this subject, I become more angry about it.  Congress birthed this atrocity, and Congress protected it against diligent and persistent Bush Administration efforts to kill it. 

For all these reasons, the FHA projects that it will pay out claims to lenders on one out of every four loans made in 2007 – the worst rate in at least three decades.

A 25% claim rate is hideous – but fortunately, Risk = P x L, where P is Probability of default and L is Loss given default.  We can hope for improved recoveries, since the newer-vintage delinquencies are borrower weakness, not property weakness.

The claim rate should be nearly the same on the vastly larger volume of loans made in 2008.

In any case, we can see FHA coming out the other side.

Dirty but still breathing

The FHA-backed loans made in 2009 tended to go to borrowers with higher credit scores than in previous years. These borrowers turned to the FHA when the mortgage market collapsed and other lending sources dried up. By then, reputable lenders doing business with the agency were already imposing tougher restrictions on FHA borrowers, further boosting the credit profile of those loans. The average credit score of an FHA borrower is now 690, up from 630 only two years ago, agency officials said.

These higher-quality loans are expected to result in lower losses, so the agency should make money on loans issued this year and over the next few years, according to an independent audit designed to gauge the agency’s health.

The audit, released in November, found that the cash the FHA set aside to pay for unexpected losses had dipped to historic lows, well below the level required by law. As of Sept. 30, those reserves were estimated at $3.6 billion, down from nearly $13 billion a year earlier. The most recent figure represents 0.53% of the value of all FHA single-family-home loans – far lower than the 2% required by Congress.

Certainly that is low, but compare that against the $3.8 billion “extra” premium FHA earned this year, and if you add that back, you’re at 1.06%, which is not great but is heading the right way.

Yes, I admit it’s getting better

It would become even rosier if, as most private lenders do (and the GSEs did), one counts the capitalized value of the future servicing rights as assets.

But Ann Schnare, a former Freddie Mac official, said the situation could be even worse. She said the audit underestimates future losses because it does not take into account all loans that are now overdue, only those that the FHA has paid claims on.

True enough, but with FHA mortgage insurance, the lender normally assigns the loan as quickly as possible, thirty days after the default.

Stevens said his agency has pored over its data to analyze risk and is taking steps to shore up its financial health. “You have a limited set of options under these circumstances: Raise fees [for borrowers] or make policy changes,” Stevens said in an interview. “We’ve done both.”

In short, tighten credit, limit losses, hence increase profits.

The agency banned 268 lenders from making FHA loans last year, more than double the total terminated in the previous eight years. The FHA suspended six other firms. Among them were some of the largest FHA lenders – Taylor, Bean & Whitaker and Lend America, both of which shut their doors soon thereafter.

The long-overdue cleanup continues.

You made the mess, you clean it up

The agency also proposed a rule that would require banks to hold up to $2.5 million in capital that they can use to repay the agency for losses if they were involved in fraud.

Absolutely!  Originators should always take first loss, and should have liquid capital to cover a substantial loss rate; otherwise the principal-agent risk is too great.

Banks are now required to hold only $250,000.

Not enough.  A ten multiple is a good idea.

Borrowers are also facing tougher scrutiny from the agency. People taking out FHA loans will have to pay higher upfront fees, perhaps as early as this spring. Those with especially weak credit scores will also have to put down at least 10% instead of the usual 3.5% down payment. The amount of money sellers can kick in toward closing costs and other fees will also be limited.

Another Nehemiah abuse being shut down.

Should have pressed the Nehemiah shut-down button a long time ago

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After graduating from a Division III college, normally an athletic platform roughly equivalent to MIT’s, he made it into professional football with the upstart American Football League.  Despite being built like a normal person (5′ 10″, 175), he flourished for a decade, winning two AFL titles and one AFL MVP award. 

Gaining an appreciation for the American black experience?  Kemp on the run

Kemp was, I think, the first American who rode sports success into politics.  Nowadays we think nothing of having Jim Bunning in the Senate, or Steve Largent and J. C. Watts in the House – back in 1971, for a football to win elective office was either a joke or a novelty (and, as Jesse The Brain Ventura later showed us in Minnesota, sometimes too much a novelty) – but his real success, at least in housing, was his single term as HUD Secretary under President Bush 41.

“Pro football gave me a good perspective. When I entered the political arena, I had already been booed, cheered, cut, sold, traded, and hung in effigy.” – Jack Kemp, 1996

Not to mention, “chewed out by the best”

Kemp’s predecessor was the narcoleptic Samuel Pierce, on whose soap-opera-fueled watch HUD experienced its worst scandals ever (and that is saying something), and he entered the building, under Pierce’s tenure as a place for being quietly irrelevant, in much the manner of the Tasmanian Devil in a  Bugs Bunny cartoon.  He was a whirlwind of ideas, including:

1. Reorientation of public housing toward residents as principal customers. 

2. Lobbying for an American version of UK stock transfer.  Kemp promoted Homeownership and Opportunity for People Everywhere (HOPE), under which public housing would be sold to tenants.  (Congress appropriated only a tenth of what he sought.)

3. Creation of Empowerment Zones.

4. Welfare reform with a temporary rent-increase freeze for people who get jobs, to get them out of the means-testing poverty trap.

“Uh oh, the Secretary’s got another idea.”

Himself entirely self-made, Kemp believed in the universality of aspiration – that anyone could make more of his life, and everyone should have the chance to make more of his life.  Government should create opportunity, insist on personal responsibility, and be intolerant of indifference.  Kemp entered a Republican Party dominated by a country-club ethos, where homilies about personal responsibility could serve as a cloaking device for bigotry and indifference.  Kemp would have none of that; he often joked that he’d showered with more black men than many of his colleagues had ever met.  Along with Newt Gingrich, who was and is far more inflammatory and confrontational, Kemp was a driving voice that the Party of Lincoln should be the Party of Responsibility and the natural party of aspiring immigrants.  In this he was the beacon for other Californians as diverse as Ronald Reagan and Arnold Schwarzenegger.

A man who never lost his enthusiasm: Kemp and Henry Cisneros

Kemp’s successor at HUD was Henry Cisneros, a charismatic former mayor of San Antonio who represented the new breed of housers – Hispanic, technocratic, rising up from the municipal level.  When Cisneros too left office, Kemp and he forged an intellectual bipartisan tag team on numerous urban policy issues, creating a National Commission on Fair Housing and Equal Opportunity, and co-authoring a book with Cisneros (and Kent Colton of the NAHB, plus AHI affiliate and Harvard JCHS chair Nic Retsinas), Our Communities, Our Homes, advocating continued reinvestment in affordable housing in cities. 

Available from JCHS

Beyond HUD, Kemp championed a flat tax, personal retirement savings (hence the Kemp-Roth IRA), and legal immigration.  He actively advocated free-market reforms in Africa.

Over his years in public service, Kemp grew on me.  At first I thought him a wild man, impractical and prone to firing off ideas without thinking about their achievability.  Over time I find that so much of what he advocated, I’ve embraced as sound policy, even if I’ve used different approaches to turn the ideas from the realm of the conceivable to the realm of the implemented. 

Really, he’s paying close attention!
Jack Kemp and DAS – October, 2005, Harvard’s Kennedy School

Really, he’s paying attention!
Senator Barack Obama and Jack Kemp, 2006 

In a curious way, long-time New York foe Senator Charles Schumer pronounced Kemp’s epitaph twenty years ago, when he said: 

“Good ideas with money can do a whole lot. Good ideas without money aren’t probably going to do a whole lot.” 

Only in America?  Jack Kemp

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