A $16.3 Billion Hole, They Say


Following the sub-prime bubble's collapse, someone had to take over subsidized lending to people with not enough income to pay back their mortgage loans, or so the thinking among the political class seems to have gone.

To be underprivileged in today's society means two things: 1. you most likely enjoy amenities that would have been the envy of every king of 150 years and longer ago, and 2. you can't afford buying a house.

The latter is regarded as a defect in need of rectification, predominantly by the political left, but as some readers may recall, the 'ownership society' was propagated in this context by the right as well.

It was apparently not enough to drive the GSE's Fannie and Freddie into bankruptcy and conservatorship by a combination of reckless monetary policy and equally reckless political mandates regarding the provision of lending to the above mentioned 'underprivileged' class at conditions that can only be called insane.


No, the FHA had to be driven to the wall as well. Well, mission accomplished, as they say. With qualifying borrowers only needing 3.5% down payments, it was clear that the FHA would pick up precisely where a great many now broke subprime lenders left off. Thus 25.82% of its 2007 loans, 24.88% of its 2008 loans and 12.18% of its 2009 loans are now delinquent. The total insured FHA mortgages amount to $1.13 trillion, so there is a big tab coming down the pike for the tax cows.

Not surprisingly, a recent audit found the agency to be short a dollar or two, or more precisely, $16.4 billion (and presumably, counting). It appears in fact as though this number may be an artificially low-balled estimate.



According to press reports:

“The U.S. Federal Housing Administration is facing likely losses that will swamp its capital and fuel a $16.3 billion deficit, but the Obama administration plans to take steps to try to avoid the need for taxpayers to bail out the loan insurer.

An independent audit found a gauge of the agency's capital adequacy had dropped into negative territory, the Department of Housing and Urban Development said on Thursday.

The findings likely mean the agency, which insures about one-third of all U.S. mortgages, will need taxpayer funding for the first time in its 78-year history. They also appear certain to fuel a long-standing debate on the government's role in supporting the housing market.

The audit showed the FHA had exhausted the capital it would need to cover losses on the $1.1 trillion in loans it guarantees. It is legally required to maintain a 2 percent capital ratio, which is a gauge of its ability to withstand losses, but it has not met that target in almost four years.

The audit found that the ratio had dropped to negative 1.44 percent, representing a negative economic value of $16.3 billion, the department said.

"During this critical period in our nation's economic history, FHA has provided access to homeownership for millions of American families while helping bring the housing market back from the brink of collapse," HUD Secretary Shaun Donovan said in a statement.

An audit last year found the FHA, a primary source of funding for first-time home buyers and those with modest incomes, faced a nearly 50 percent chance of needing a bailout. Full details of the latest audit will be released on Friday. The FHA has never needed an infusion of funds from the U.S. Treasury because it has been able to take other actions, including raising insurance premiums, to stay solvent.”


(emphasis added)

Mr HUD secretary seems to be saying: “even if we eventually manage to lose so much money that the tax cows will have to bail us out (because other avenues to plug the holes in the balance sheet turn out to be insufficient), it is 'critical' that we continue to make loans a quarter of which appears to become delinquent in short order”.



The FHA's capital ratio over time (chart via CLSA); at the height of the bubble, it appeared to be in fine fettle. Since then it has become the major subprime lender, with results that are exactly similar to the experience of the previously extant subprime lenders – click for better resolution.



Actually, it's a $32.8 Billion Hole!

It turns out that if one digs a little deeper, the FHA's capital ratio deficit is actually twice as big as currently advertised.

According to the Investors Business Daily:

“Ed Pinto, a resident fellow at the conservative American Enterprise Institute, says the truth is even worse.

"Today's report is already obsolete and outlines a conservative estimate of the true losses incurred by the FHA," he said.

FHA's actuarial study, he notes, assumes 10-year Treasury yields will average 2.2% in Q3 2012, soaring to 4.59% in 2014. It also assumes mortgage rates will double to 6.58% by late 2014.

But a low-rate scenario is more realistic, Pinto claims. The 10-year Treasury yield is 1.58% now. In September the Federal Reserve said it would keep the federal funds rate near 0% likely through mid-2015, suggesting that mortgage rates are unlikely to rise soon.

Deep in the FHA's actuarial analyses, capital reserves would be -$32.8 billion in a low-rate scenario. Low rates would let good borrowers refinance, leaving the FHA with the bad loans.

That's a far cry from last year when the FHA projected its capital reserve would be $11.5 billion.

The FHA has vastly expanded its exposure to mortgages in recent years, picking up the slack — and risk — from Fannie Mae and Freddie Mac.

The FHA says it will take various steps to improve its finances, such as an uptick in insurance premiums. But it largely blames its capital woes on loans "insured prior to 2010." Over 30% of loans in much of 2008 and 2009 had FICO scores below 640. That's fallen to less than 10% in the most recent quarter.

The FHA claims that the loans "endorsed since 2010 continue to exhibit very strong performance" and the quality of those loans "is the best in FHA's history." But Pinto says that FHA is still making a lot of risky loans, many with with subprime attributes such as FICO scores below 660 and debt-ratios of 50% or more."

FHA data that IBD received bear that out. Of the 900,000 fully underwritten loans FHA insured in fiscal 2012, 39% had FICO scores below 660 and/or a debt ratio of at least 50%.

There are other trouble signs. The FHA paid out on 143,000 claims in fiscal 2012, much higher than the 118,500 it had predicted and above the roughly 118,100 paid in FY 2011.

FHA's delinquency rate has risen as well, going from 16.6% in September 2011 to 17.3% a year later. Some 1.3 million of its nearly 7.7 million outstanding loans are behind on payments.”


(emphasis added)

So in reality it's a $32.8 billion deficit and counting. Note also that the above strongly indicates that the FHA's own forecasts are worth exactly nothing, or perhaps about as much as Ben Bernanke's assessment of the soundness of the housing bubble between 2003 to 2007.  OK, we might as well stick with 'nothing'.





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