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Did the US make FHA into a new Countrywide at taxpayers expense?

I was very hesitant posting a press release from a political office as this FHA problem was caused by banksters and politicians.  However, the press release had some very good descriptions on what happened to FHA in the past 6 years.   In a nutshell, some of the functions of the subprime private mortgage insurance industry were taken over by the FHA.  That’s explains the reference to Countrywide Mortgage by Chairman Hensarling.

Last week I posted discussing the affect of low mortgage rates and the increase in purchasing power.  Larry Roberts discussed the role of the US in subprime lending or even whether should there be a role.  FHA helps to facilitate credit to borrowers that normally shouldn’t be qualified to receive it and lowers the down payment barriers for all prime and subprime borrowers.  Not all FHA borrowers are subprime, but it allows low FICO score borrowers which increases the risk in the FHA pool.   More subprime borrowers translates to higher defaults rates and larger losses at FHA.  In addition the low down payments means costlier defaults and larger bailouts from the US taxpayers.

Chairman Hensarling: “Open Question Whether FHA Has Now Morphed into Countrywide. Arguably, the FHA Has Now Become the Nation’s Largest Subprime Lender”

Washington, Feb 6 -

WASHINGTON – House Financial Services Committee Chairman Jeb Hensarling (R-TX) delivered the following opening statement at today’s hearing on the proper role of the Federal Housing Administration (FHA) in the nation’s mortgage insurance market.  Today’s hearing is the first in a series of hearings the committee plans on the FHA. 

“Last week many of us awoke to news that we had negative economic growth in the last quarter. Although one quarter a trend does not make, it was not welcome news; it was not expected news.

“Unfortunately what has become expected news is subpar 1 ½ – 2% economic growth; when historic trends are above 3% and clearly the economy is capable of 4% or greater.

“2% economic growth means that millions of Americans lay awake at night pondering insecure financial futures for themselves and their families.

“Hardworking Americans demand a healthy economy and we cannot have a healthy economy until we have a housing finance system that is both sustainable and competitive.

“In its current form FHA is clearly an impediment to such a system.

“Because of this, the Financial Services Committee today is holding its first in a series of hearings to examine the FHA, now the largest mortgage insurance company in the United States.

“Historically, FHA has represented roughly 10% of the mortgage insurance market and has fulfilled its role of being the provider of mortgage credit for certain discreet populations – particularly first-time homebuyers and low- and moderate-income Americans — who qualify under stringent tests.

Actually, 10% of the market share of FHA only occurred several times.  In some pre-bubble years FHA market share decreased to 5%.  In addition, during normal housing appreciation many FHA borrowers moved up the housing chain and purchased bigger houses.  However, this move up market will be very limited in the next couple of years.  The added volatility of the housing market could mean that FHA borrowers strategically default the market value of their home drops.

“Today, however, FHA has strayed far from its original mission and legislative purpose.

“It doesn’t just focus on low- and moderate-income Americans; it provides mortgage insurance for expensive homes valued as high as $729,000.

FHA is supplying high priced areas a way to artificially create more demand. On a $750,000 home purchase the buyer would normally put a minimum $150,000 as the down payment, the FHA 3.5% down payment  buyer would put $26,250.  This allows more eligible borrowers in the buyer pool, but also increases the chance for defaults.  The borrower that puts down $150,000 is less likely to strategic default and lender can cover the potential losses with at least LTV of at 80%

“By offering riskier terms than private competitors, the FHA today controls 56% — well more than half — of the total mortgage insurance market in terms of numbers of loans, talk about Too Big to Fail.  So instead of complementing a robust private mortgage market, the FHA high cost loan limits and extremely low down payment requirements put it in direct competition with the private sector.

“In addition, we know that as bad as that is, its single family insurance fund is flat broke.

“The independent actuarial study released last November shows that the FHA single-family mutual insurance fund has a negative – I repeat, negative – economic value of $16.3 billion.

What is not at stated that the total losses after all the projected defaults will be about $150 billion.  It will take years to realize this because FHA borrowers are allowed 2 modifications trials before actually reaching default.  In addition, if you live in a judicial state it can take even longer.

“If the FHA were a private financial institution, likely somebody would be fired, somebody would be fined, or the institution would find itself in receivership.  Instead, it is merely, and merrily, on its way to becoming the recipient of the next great taxpayer bailout.

“Finally, given their high Loan-To-Value, low credit score policies and high rates of default, it is an open question whether FHA has now morphed into Countrywide. Arguably, the FHA has now become the nation’s largest subprime lender – all with the blessing of the Administration.

That’s the political part, both the right and left are to blame.  When FHA Lowered it’s conforming loan limit $625,000 John Campbell, a Republican, pushed to increase conforming limit back to $729,000.  It”s a Washington issue.

“FHA’s loan down payments lure families into having an unrealistic view of homeownership obligations.  Their high home loan limits encourage people to buy more home than they can possibly afford to keep. Putting borrowers in homes where 1 in 8 loans end in default, the FHA can make entire communities worse off, trapping more and more families as property values fall.

“You do not help families achieve the American dream by putting them into homes they cannot afford. This is how you turn the American dream into a nightmare.”

I believe most politicians don’t even understand how credit markets work.  Credit cards have high interest rates because borrowers can default on their debt and usually default first on credit cards.  Credit card borrowers have no skin in the game and can walk away into bankruptcy causing thousands of losses to the credit card company.  This risk is priced in to the credit card interest rate.  A house secured by a mortgage with a 20% down payment has lower risk of losses to the lender.  The lender has ability to foreclose on house to recoup it’s loses.  The risk is lower to the lender and therefore the mortgage rate is lower than an unsecured credit card.

An FHA mortgage is somewhere in between, it’s secured by an asset but with the low down payment it will result in losses to the lender if the borrower defaults.   That’s why you pay a mortgage insurance on FHA mortgage to cover this additional risk, or the FHA mortgage rate would much higher mortgage rates without this insurance.  In addition you are letting subprime borrowers eligible for FHA loans with adds additional default risk into the FHA mortgage pool.  In summary, the government has demonstrated that it doesn’t know how to price risk into the mortgage insurance payment to insure the taxpayers don’t get stuck paying for the losses for FHA mortgages.  My proof? The expected $150 billion dollar bailout by some banking experts.  Based on this information should they continue the FHA program?

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