FHA Highly Leveraged, Lacks Reserves to Cover Losses

Published December 5, 2011

“How much money are the taxpayers supposed to throw at housing so people can put down 5 percent or less and pay a government-subsidized low interest rate?”

That’s the question Mises Institute President Doug French asked in response to the news the Federal Housing Administration’s auditors predict a 50-50 chance the FHA could need a taxpayer bailout within a year.

The FHA now backs one-third of all residential mortgages being written, up from 5 percent just five years ago.

“The housing market is not going to clear as long as Fannie Mae and Freddie Mac [government-sponsored entities that are also major players in the mortgage market] are kept in business and fraudulent insurance programs like FHA continue,” French said. “Of course, the FHA isn’t ‘insurance’ at all but a redistribution benefiting the housing industry that has benefited from government subsidy and cheerleading since Herbert Hoover’s ‘own your own home program.'”

Just $2.6 Billion in Reserves

An audit of the FHA’s Mutual Mortgage Insurance Fund by Integrated Financial Engineering Inc. of Rockville, Md., notes the FHA’s reserves stand at just $2.6 billion, down 45 percent from $4.7 billion one year ago. That’s on approximately $1 trillion of loan exposure in 2011, up from $305 billion at the end of 2007.

Continuing declines in the housing market could lead to more defaults and foreclosures and push FHA losses directly onto the backs of taxpayers.

“As was the case last year, the new actuarial study shows that FHA is expected to sustain significant losses from loans insured prior to 2009, and thus its capital reserve remains below the congressionally mandated threshold of two percent of total insurance-in-force,” the Department of Housing and Urban Development noted in a statement. “However, the actuaries’ report concludes that, barring a further significant downturn in home prices, the MMI Fund will start to rebuild capital in 2012, and return to a level of two percent by 2014—outpacing last year’s prediction.”

The Reason Foundation’s director of economic research, Anthony Randazzo, warns HUD’s confident tone should be taken with a few grains of salt.

Leveraged 422 to 1

“Bookkeeping at the FHA is notoriously sloppy, and I would not be surprised if the bailout odds were really closer to 75-25,” he said. “The reality is that the FHA is dangerously overextended. The FHA’s capital buffer has been below the congressionally mandated minimum since 2009.

“And consider that Lehman Brothers was leveraged 32 to 1 when they went bankrupt. The FHA is currently levered at 422 to 1, according to the actuarial report,” Randazzo said.

Congress created the FHA some 80 years ago to insure loans to persons at the lower end of the economic scale. Those borrowers could obtain FHA loans with 3 percent down payments. In many instances, the FHA allowed borrowers to finance some of the down payment, leaving those borrowers to put down as little as 1.5 percent.

With the FHA backing one-third of all new mortgages, it has expanded well beyond its traditional low-income niche and into the market traditionally covered by private lenders.

“Private lenders will finance homes. But they will demand larger down payments and rates higher than 4 percent [the current rate on a 30-year fixed-rate loan],” French said. Noting taxpayers are being put on the hook so “people can put down 5 percent or less and pay a government-subsidized low interest rate,” French added, “Lawmakers should sweep FHA into history’s dustbin. But they won’t. Housing is a sacred cow in Washington. “

90 Percent Federalized

Ronald Utt, a senior research fellow in economic policy at the Heritage Foundation, notes the FHA has gone from “almost totally forgotten” 15 years ago to an important part of a mortgage market that is now almost entirely federalized. More than 90 percent of mortgages now go through Fannie Mae, Freddie Mac, or the FHA.

“By elevating the FHA to a more prominent position, we are subjecting the FHA and taxpayers to all of the problems that continue to exist in the depressed mortgage market,” he said. “Home prices continue to fall. The private sector lenders are increasingly skeptical about what their rights are. They can’t foreclose. People are engaging in strategic defaults. They reason, ‘Why buy something that is worth less than I’m paying for it?'”

On the other hand, Utt said, major mortgage lenders who know how to game the system are happy to keep things as they are.

Contractors to Government

“Wells Fargo and Bank of America are making money not in holding mortgages but in making mortgages. They have guaranteed buyers in Fannie and Freddie. The private sector is happy to be profitable contractors to the federal government,” Utt said. “They are resistant to any effort to shift more responsibility to a recreated private market. They have a good deal now. They are making billions of dollars sending mortgages off to Fannie and Freddie.”

Utt recalled in the late 1980s and early 1990s there was a “select real estate recession” in California, Texas, and certain other states that put the FHA in financial straits. Jack Kemp, then U.S. secretary of housing and urban development, cut out risky loans and improved FHA management to avoid a taxpayer bailout.

“I don’t know if they can do that now,” Utt said. “I don’t see a quick turnaround in housing, and financial industry lobbyists are opposed to a restoration of the private market. It’s profitable and risk-free for them, and it doesn’t get much better than that.”