Is a Bailout for the FHA In the Works?

Americans now own Fannie Mae and Freddie Mac, the combined $5.2 trillion, heavily politicized housing finance companies nationalized in the fall of 2008, bringing to taxpayers large sums of subprime, no doc, alt-A loans and securitizations that no one wants, backed by abandoned houses.

U.S. taxpayers also own their cousin, the Government National Mortgage Association (Ginnie Mae), the government cheese program of mortgages, as it also is fast becoming a trillion-dollar purveyor of loans and securitizations.

And U.S. taxpayers may soon be asked to bail out the Federal Housing Administration, which insures Ginnie’s loans, two million of them.

This week the FHA delayed the release of its annual audit, which can only mean bad news and behind the scenes chaos. Meaning, taxpayer dollars will be needed to rescue it.

Thanks to the impenetrably foolish four horsemen of government mortgages (Fannie, Freddie, Ginnie, and the FHA), the U.S. taxpayer now insures about nine out of every 10 new mortgages.

The FHA seems to have avoided the bad loans wrecking the banking industry now. “FHA stuck to the basics during the housing boom: 30-year, fixed-rate traditional loan products with standard underwriting," and not insuring mortgages like no-doc or subprime loans, says David H. Stevens, assistant secretary for Housing and the FHA Commissioner for the Department of Housing and Urban Development. 

However, the FHA has mismanaged its capital cushions to support its business, at a time when the Congress and the Administration have leaned on the FHA to do more to help homeowners buy homes - to potentially catastrophic consequences for the U.S. taxpayer.

To support its business, the FHA has a rainy day fund the size of a teacup compared to the mounting losses it now faces.

These developments couldn't come at a worse time for the agency, as Congress has pushed the FHA to take on even more business. Legislation has been in the works to maintain the FHA’s loan limit in high-income states such as California at $729,750 (not exactly first-time home buyer amounts, don’t you think?)

By pushing the FHA to extend the higher loan limits that were set to expire at the end of the year, Congress potentially just doubled down on the taxpayer tab, notes Fox News analyst James Farrell.

According to the HUD inspector general, the FHA, which has virtually no strong oversight against fraud, now backs $560 billion of mortgages. That’s four times what it was insuring three years ago.

Last summer, HUD’s Inspector General issued a withering report on the FHA, finding that its default rate zoomed to 8.4%, almost triple what the big banks and mortgage lenders say is safe; most recent data available shows nearly one out of seven of these loans were more than a month delinquent, headed for default.

The FHA provides a portrait in miniature of the twilight years of the credit mania: it expects 24% of its 2007 mortgages and 20% of its 2008 mortgages to go into default. 

But the crowd running the FHA let its rainy day reserve fund shrivel to $30 billion to support its business, a cushion that has halved to 3% from 6.4% in 2007, and a cushion that is set to fall below 2%, HUD says.

Now, the FHA does not hold debt on its balance sheet, and instead is financed from mortgage insurance premiums paid to FHA in exchange for providing mortgage insurance.

The reserve is essentially a cushion above and beyond anticipated future losses, no matter the timing of those losses.

However, Stevens warns that because the FHA has not set aside enough in reserve, that even the FHA says it likely will not be able to handle looming losses.

"FHA expects higher net losses than previously estimated on outstanding loan guarantees over the next 30 years and more than are currently reserved for in the financing account," says Stevens.

How much could taxpayers be on the hook for? The Wall Street Journal says potentially another $50 billion to $60 billion.

Stevens and friends of the FHA are quick to dismiss the Wall Street Journal’s reporting, that the FHA was levered up much like Bear Stearns. Remember, though, “Bear ate through about $20 billion in cash on hand in about a week,” notes Farrell.

“I know that it is like comparing gas guzzling of a Hummer versus a Prius because of the differences in business models, but two years ago no one would have said it was possible for Bear to eat through that much cash in that short a period,” Farrell says.

Farrell also believes the delay of the FHA audit “can be seen as part of the continued machinations of the administration to try to persuade people that the economy is not as bad as it is during the aggressive push for health care.”

Sort of like the jobs ‘saved/created’ chicanery, where the Administration is telling government agencies to count "as jobs saved" a fraction of its workers who have been given a raise.

Farrell adds that the Treasury Department just avoided having to get Congress “to increase the federal debt limit immediately by cutting by 43% the amount it planned to borrow this quarter, essentially by pushing it into next quarter." 

Congress will still have to increase the debt limit, but not until December. “This might have been done to give the administration breathing room to pass the deficit expanding health care reform and then jam through the debt increase before Christmas when no one is really paying attention,” Farrell says.

Don’t’ be fooled by FHA-speak, and any defenses of FHA, when the audit is finally released.

Specifically, don’t be fooled by talk that the reserve amount is “the cushion above and beyond anticipated future losses (regardless of the timing of those losses).”

Yes, it is above and beyond the net present value of future actuarial losses.  However, because it is a net present value calculation, timing is important, plus this calculation is an estimate, an assumption, Farrell says.

Likely not released will be the details of how the government arrives at those assumptions.

So if you care about yet another taxpayer bailout of a mismanaged government housing program, be skeptical of government’s estimates.

If they are too optimistic, and housing prices fall below their assumptions, then that means more taxpayer money. Watch for details on the default rates the government is using, the number of houses they expect to go underwater, and what housing values it uses as the baseline for the hits that the FHA would take on its portfolio.