NEW SUBPRIME LOANS WILL COST US BILLIONS: RICHARD FINGER
http://www.forbes.com/sites/richardfinger/2012/09/30/meet-the-new-subprime-it-will-cost-us-billions/
When will our government come to realize that not everyone in this country can own a home? Not an issue of cruelty or insensitivity or lack of dream for Utopia, but a simple matter of economics. Not everyone has 20% or even 10% to make a bona fide down payment and have the subsequent income to comfortably service the debt. Apparently the continuing pain of the subprime crisis has taught our feckless politicians nothing. While sub-prime has morphed into a naughty word, a near clone has stealthily infiltrated the mortgage markets, choking the breath out of many unfortunates ensnared by its enervating tentacles. Meet the Federal Housing Administration or FHA. It found life under Roosevelt in 1934 as part of his alphabet soup answer to extricate America from depression. It started as a benign institution, and like today, insured loans and offered some down payment relief to borrowers.
Why Has FHA Become A Monster Now
UD) under whose purview FHA falls, issued the September 30 fiscal year 2011 annual report. It was a rather damning indictment. Capital which is statutorily set at 2% of assets had fallen to a measly .24% or from $4.7 billion in 2010 to $2.6 billion in year end 2011. It is only a mere $20 billion shy of requirement. This capital is expressed as the MMI or Mutual Mortgage Insurance Fund or the backstop to any defaults on the $1.1 trillion of FHA insured loans outstanding. The auditors estimated $26 billion of losses for loans underwritten through the first quarter of 2009 and another $14.1 billion for “seller funded down payment assistance loans”. Though since curtailed, the seller used to be able to loan the purchaser most or all of the down payment leaving the buyer with little or no “skin in the game.” Then the auditors sang the praises of the 2010 and 2011 books of business will be profitable, and there are new risk guidelines and credit policies in place and all is well and they expect to be in capital compliance by 2015.
A large part of the problem is that to qualify for a mortgage at FHA you need little more than an active “pulse”. Requirements have been repeatedly watered down. The down payment requirements are 3.5% with a credit score of 580. A score below 640 is considered subprime by the Federal Reserve. When you roll in the insurance fee into the loan balance you have a loan to value ratio that starts at over 98%. The paltry down payment may be funded by relatives or employers. It gets more bizarre. Borrowers can claim income from a roommate (to be found at a later date) to help qualify for the loan. Often no cash reserves are required to demonstrate ability handle repair bills and taxes and still meet mortgage obligations. In addition, when you default you just go and apply to the pernicious Home Affordable Modification Program or HAMP which is designed to give our beleaguered mortgagor several more bites at the apple. His or her loan will be modified (interest rate reduced or principal forgiven) and because of new more lenient HAMP rules, when she or he defaults again, the loan can be rejiggered yet one more time. All the income requirements at HAMP have been reduced more than once. HAMP also has one of those goofy phantom roommate clauses.
Fannie Mae Compared
The contrast between FHA and Fannie Mae tells the story. First Fannie Mae issues what are known as conforming or “conventional” loans which have such requirements as 20% money down and cash reserves for repairs as well as infinitely stricter income requirements than FHA. Second, and insidiously, FHA now has a loan limit that is higher than Fannie Mae. Ex Alaska and Hawaii, FHA has loan limits up to $729,750 while conventional mortgages are stuck at $625,000. So in effect there has been a “disintermediation” away from Fannie and into FHA. If you have little cash the lax requirements of FHA is the siren call. This is borne out as FHA has increased threefold in size since 2005. And combined with HAMP a borrower has multiple opportunities to default with impunity, the system encourages irresponsible behavior.
Realizing that perhaps this Ponzi scheme can’t endure indefinitely, FHA has raised their insurance premiums to borrowers twice this year, most recently with Congress giving, with a 402-7 vote, it’s imprimatur on the FHA Fiscal Solvency Act which raised cost of insurance to up to 2.05% annually. The bill announced more hollow risk guidelines and even hired a new risk officer to make sure all roommates are in compliance. HUD Secretary Donovan emerged from his cave and hailed this would ensure the solvency of FHA.
Meanwhile, economists at the Federal Reserve were crunching some numbers of there own. FHA has for years underestimated their losses from claims on defaulted loans. It turns out that every time FHA has a loan default but it gets modified into a new loan, then this loan is a success and hence not counted as a defaulted loan. In fact, this default is a default and not a success and to the extent it has been modified (lower interest or principal) it cost me and you the taxpayer, money. Additionally, it was discovered that 49% of all reworked loans defaulted a second time within twelve months. The bottom line is FHA uses a faulty econometric model that vastly underestimates defaults to forecast losses. The Fed, which used actual FHA loan data from 2007-2009, predicts there will be a 30% default rate on these loans within five years.
Some Mind Blowing Statistics
So on the one side of the aisle sits HUD secretary Donavan pontificating all is well in FHA land, while on the debit side of the ledger the Federal Reserve has produced a significantly less sanguine vision for the future. Skeptic that I am, I tend to believe half of what I see first hand. Ergo, I embarked on a little sleuthing mission to compare the credibility of each stance. Locating the latest 10Q’s (second quarter 2012) for JPM, BAC, and WFC, I combed the nether intestines in search of their FHA loan exposures and what is the current delinquency experience. Sobering understates the resulting data. BAC, far and away the largest FHA lender of the three has a $67.3 billion book of which $18.1 billion or 26.9% is 90 days or more past due. It gets worse. Government guaranteed loans at WFC total $28.43 billion and a whopping 69.3% fall into the 90 day overdue basket. JPM brings up the rear with a comparatively small $15.9 billion but with an incredible 74.8% being derelict by three months or more. When you add up these three lenders you arrive just under $112 billion or 10% of the total $1.1 trillion FHA insured market. Take my word, in aggregate the math and division yields that nearly 45% of all of these FHA insured loans are three payments or more behind. That is $49.5 billion of loans more than three moths past due. The FHA has $2.6 billion in capital. Can we extrapolate to the other 90% of the market? Who knows, but these three banks have operations covering areas in excess of 95% of the population of America.
Bailout
What if there were 20% losses on just that $49.5 billion delinquent. That’s almost $10 billion, and four times the current FHA capital buffer, and that’s just 10% of the market. What if losses are 30% or 40%? Losses on FHA loans can easily expand into the hundreds of billions on the shoulder of the taxpayer. The day of reckoning keeps getting postponed because it’s just not fair to foreclose on borrowers just because they haven’t made a payment in a year. It is a dirty little secret that will be kept in the linen closet until after the election. This debacle can only end up in a bailout scenario. The government has only itself to blame here. The nefarious banks had nothing to do with this one. Everybody is entitled to shelter but not everyone deserves to own a home. FHA is broke, bankrupt, insolvent……dead and it is going to cost us billions.
Stupidity Of It All
Putting people in homes where there is little probability of a successful outcome is negative for all parties. Credit is damaged and ever more difficult to obtain in the future and relocating to find a job becomes more challenging. What causes the most dissonance is the utter moral collapse of our system. Borrowers are able to default three, four times with no real repercussions. The sense of responsibility to pay back a debt incurred is gone. It is part of the politically correct world that is decimating the American culture. I have said this in several of my articles, but these people were never owners, just renters. There was no pride of ownership because the commensurate work to earn the home was never there to start with. My daughter ran for student council with six girls vying for four spots. The votes were tabulated and it was determined that rather than wound self esteem, all six were declared winners. I was repulsed. Far better to have my daughter lose and learn a lesson or win and have the pride to know she earned the position. This is now how our society is being constructed now. At the end of the day the FHA, so far strayed from its mission, is now just another entitlement program and HAMP but a government pustule on this seeming inexorable march to socialism. I am probably just another Cassandra relentlessly forewarning to deaf ears, but I hope not.
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