Should We Dump Toxic Loans On The FHA?

by Peter G. Miller
August 23rd, 2007

The Washington Post reports that “the Bush administration is considering broadening the FHA’s mandate to help borrowers avoid foreclosure. The administration is studying the possibility of allowing the FHA to take on mortgage refinancings for borrowers in default, something the agency is not currently permitted to do, a senior official at the Department of Housing and Urban Development said.” (See: U.S. Ponders a New Deal for FHA, August 23, 2007)

This is what you call a trial balloon. Notice that it was suggested by a “senior official” rather than by an actual human being.

On a humanitarian basis the idea of bailing out homeowners is certainly attractive. However, there are huge problems with this proposal.

First, homeowners can get FHA financing today. What the Bush Administration is really proposing is to allow refinancing without meeting current FHA standards — otherwise why would any new effort be required?

Second, while the spin is about helping “borrowers avoid foreclosure,” the real winners in this effort would be the lenders who made such loans and the investors who now hold them. In effect, Uncle Sam would pay off lousy loans when homes are refinanced.

Unfortunately, this brings us to the third item: Many troubled borrowers cannot refinance their loans because they lack equity — remember many toxic loans have negative amortization so in a large number of recent situations we have loans with growing balances and homes with declining values. Is Uncle Sam going to make loans at 100 percent or above?

Fourth, many homeowners do not have sufficient income to pay an FHA loan at current interest rates plus a .5 percent insurance fee. Is the government going to allow stated-income loan applications as private-sector lenders have been doing? You can see how well that works.

Fifth, a few years down the road, if that long, there will be massive claims against the FHA insurance fund. Taxpayers will wind up paying the bill.

Of course, by then, our “senior official” may be retired on a government pension for all his or her good work.

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This entry was posted on Thursday, August 23rd, 2007 at 3:11 pm and is filed under . You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.

4 Responses to “Should We Dump Toxic Loans On The FHA?”

  1. Dan Michaud Says:

    You hit the nail right on the head. What about going after all the underwriters (trained to watch for fraud, by the way) who approved the toxic loans in the first place?

    Great article!

  2. Peter G. Miller Says:

    Dan –

    Thanks. You raise a good question.

    Underwriters are supposed to assure that loan applications precisely match the requirements of individual mortgage programs. Once loan programs standards were reduced, underwriters had very little to check — how can an underwriter contest a borrower’s “estimated” income? What proof can be demanded with a stated-income loan application? And besides, if an underwriter holds up a deal a mortgage loan officer will be out a big commission.

    As bad and maybe worse has been the practice of placing borrowers in subprime loans when they clearly qualified for a lower-cost FHA mortgage.

  3. Evan Hodge Says:

    In regards to the post that suggested to go after the underwriters that underwrote the “toxic” loans, blatant fraud is one thing and if that were the case then so be it, but underwriters are trained on how to spot fraud and what signs to look out for. Fraud is not what has led our nation into this credit crisis of increasing foreclosures. A combination of depreciating values and zero down payment negative amortization loans has.

    Question: Did these same borrowers that are now facing foreclosure have a gun pointed to their head when they were signing their loan documents?

  4. Peter G. Miller Says:

    Evan –

    I think that fraud is a big part of the mortgage meltdown — but the problem we have is fraud by whom? The borrower? The loan officer? The lender? Loan documents are touched by a lot of people.

    As to underwriters, if they get a stated-income loan application where earnings are not checked, they lack the basic tools to determine if a loan should or should not be approved. A computerized or drive-by appraisal isn’t as good as a physical appraisal of the property. In essence, with toxic loans you don’t need underwriters because they have little to do.

    The question about guns misses the point. Borrowers depended on lenders for advice and counsel — lenders who control the flow of information making independent evaluations impossible, lenders who say they want to help borrowers but run from fiduciary relationships.

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