[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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Can a government bank fail? 

Something a little less visible than that

In the space of a week, that question’s surfaced about two governmental banks – FHA in the US and the World Bank – in stories in the New York Times (which I’ll excerpt in plain text) and UK Telegraph (in indigo palatino), but as we’ll see, the source of the evidence, and hence the threat credibility, vary extraordinarily.  Let’s start with the World Bank:

The World Bank is close to ‘running out of money’, its president, Robert Zoellick, has disclosed.

World Bank president Robert Zoellick has launched a major campaign secure more funding from rich nations

Mr. Zoellick succeeded the brilliant blockhead Paul Wolfowitz (brilliant economist, blockhead manager) and has evidently brought stability and a renewed sense of organizational worth to the World bank staff (full disclosure: I know many incredibly good people who work there).  He’s in a position to know the bank’s financial position.  However, in saying that the bank could ‘run out of money,’ he does not mean bankruptcy, but rather lack of liquidity:

The Bank, whose job it is to support low-income countries, has had to hand out so much cash in the wake of the financial crisis that it faces a shortfall in what it can spare for new projects within 12 months.

“By the middle of next year we will face serious constraints,” said its president Robert Zoellick, as he launched a major campaign to persuade rich nations to pour more money into the Washington-based institution.

Formerly open for business

The bank gets its capital from developed nations, and then makes loans to developing nations.  If those nations do not repay as timely as expected, the bank may have capital (loans receivable) without cash.  Should those loans go bad – as commercial and residential loans do, as we have discovered – then the World Bank could become insolvent, but since its creditors are sovereign nations who as a general rule are not seeking repayments to pro up their own liquidity, a more practical outcome is an inability to lend further.

Lack of liquidity or total insolvency?

That’s less serious than the problem being alleged about FHA:

A year after Fannie Mae and Freddie Mac teetered, industry executives and Washington policy makers are worrying that another government mortgage giant could be the next housing domino.

Problems at the Federal Housing Administration, which guarantees mortgages with low down payments, are becoming so acute that some experts warn the agency might need a federal bailout.

As we’ll see, this appears to mean ‘one expert.’

Running questions about the FHA’s future — underscored by interviews with policy makers, analysts and home buyers — came to the fore on Thursday [October 8, 2009 – Ed] on Capitol Hill. In testimony before a House subcommittee, the FHA commissioner, David H. Stevens, assured lawmakers that his agency would not need a bailout and that it was managing its risks.

Stevens says he’s managing the risks

Unlike most of his recent predecessors at FHA, Mr. Stevens’ background is in single-family, not multifamily.  That’s logical since the HUD secretary, Shaun Donovan, has a stronger background in multifamily, and as FHA is integral to then continued flow of housing finance capital.  Roughly a month ago, I posted about the declining FHA loan reserves; at the same, HUD Secretary Donovan said there was a better than even chance of staying above the 2% capital ratio statutorily required.  That, however, is less significant than it may seem, since, as I noted then:

The Federal Housing Administration is 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.

Nevertheless, if it proves true that FHA’s loan book goes sour – badly sour – then the government will be further on the hook.  Worse still, the World Bank could stop lending without calamity ensuing; FHA basically cannot. 

Maybe we shouldn’t have braked so hard

The government is giving as many people as it possibly can the chance to buy a house or, if they are in financial difficulty, refinance it. The FHA is insuring about 6,000 loans a day, four times the amount in 2006. Its portfolio is growing so fast that even FHA backers express amazement.

I don’t understand the Times’s phrasing there – what does being an FHA backer have to do with observing that its activity growth is a remarkable byproduct of our remarkable times?

Many Democrats insist the FHA is playing a vital role in the housing market, which is only just starting to stabilize.

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.”

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

Conversely, Mr. Zoellick wants money so he can reopen for new business. 

Zoellick conceded that such a task [Raising money from member nations – Ed.] was likely to be extremely difficult, given the difficulties facing countries in the wake of the developed world’s biggest recession since the Second World War.

Said in plain English, when you’re worried about domestic lending to your own homeowners, you’re highly unlikely to ship precious capital overseas to facilitate lending to foreign homeowners.

Make no mistake: we have reason to be watchful.

Superhero Sentry at your service

[Continued tomorrow in Part 2.]

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