Will There Be An FHA Bailout?

by Peter G. Miller
August 18th, 2010
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One of the most frequent subjects I find online regarding the FHA loan program is that it is the equivalent of subprime financing and that the FHA will soon go bust.

The first one is easy to tackle: The Mortgage Bankers Association reported in May, the latest figures available, that “the seasonally adjusted delinquency rate increased for all loan types with the exception of FHA loans. On a seasonally adjusted basis, the delinquency rate stood at 6.17 percent for prime fixed loans, 13.52 percent for prime ARM loans, 25.69 percent for subprime fixed loans, 29.09 percent for subprime ARM loans, 13.15 percent for FHA loans, and 7.96 percent for VA loans.”

So, no, FHA loans are not having subprime problems.

But what about an outright bust? Could the FHA need a bailout?

Reserves

This is a more complex question. It requires that we consider several factors.

First, as we have reported, the size of the reserves is increasing: “The FHA’s Mutual Mortgage Insurance (MMI) fund now holds $33.1 billion — that’s up from $30.9 billion a year ago. This is the key reserve for FHA loans.”

This is certainly good news, but it’s also news which needs some context. The growth of the FHA program in terms of market share has meant the system has collected a lot of up-front mortgage insurance premium money. If FHA market share declines then less money will come into the reserve fund.

No less important, HUD has announced new FHA loan requirements that will begin in October. In essence, up-front mortgage insurance premium costs will fall while annual costs will rise. The FHA is banking on greater revenues under this system over time, but it means that less money will go into the reserves as soon as a loan is originated.

Toxic Loans

But the real threat to the FHA is not anything it does or can do. The real threat to the system is a continued economic meltdown. Since April 2007 home prices have taken a beating, in some measure because the private sector did not offer loans which were as sane and secure as FHA financing. To now blame the FHA is absurd.

For instance, home prices tumble when a property down the street is foreclosed because the owner obtained a toxic loan several years ago. Now that mortgage is being re-cast and the owner is done. There are more than 300,000 toxic loans which I expect to be re-cast both this year and next.

In the worst case the FHA will borrow from Uncle Sam. That’s not a great solution but it certainly helped Wall Street and the nation’s biggest banks. That’s not a great solution, one would hope it doesn’t happen, but that is the ultimate end game if things go very wrong. Of course, by that point the economy would be in such awful shape because of the practices and policies of the last decade that bailing out the FHA will be the least of our problems.

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