Will Risky FHA Loans Prompt Another Big Bailout?

The excellent cover story last year by my colleagues Chad Terhune and Robert Berner laid out the fact that the nation’s housing market was becoming ever more dependent on the Federal Housing Administration and yet some of the same scoundrels who made risky subprime loans were now originating new loans, this time with the federal government’s backing.

Now the actions of those wolves are beginning to show. Last week the FHA announced that its capital levels may dip below the dangerous 2% level. In hearings on Oct. 8 before the House Financial Services Subcommittee on Housing and Community Opportunity, Edward Pinto, an independent financial consultant and former Fannie Mae exec, testified that the agency may need a major taxpayer bailout within the next two to three years.

The FHA now insures more than 25% of the mortgages in the country. That’s up from just 3% in 2006, as it picked up much of the slack from all the lenders that went out of business. But as Pinto noted, the FHA’s numbers are worrisome. The agency’s percentage of loans in foreclosure has nearly doubled over the past ten years to 4.4%. Its volume of loans has quadrupled since 2006, while its top loan limit climbed to $729,000 from $362,000 in the past year. The agency accounts for 90% of the so-called high loan to value loans, those where home buyers have less than 10% of the purchase price as a down payment. The less money homebuyers have at risk, the more likely they are to default.

Pinto said the FHA needs to drastically change its lending requirements, raising downpayments, lowering loan limits and requiring lenders to insure a part of the loan to keep them honest.

Even the go-go cheerleader for the industry, the Mortgage Bankers Association is calling for Congress to put on the brakes. David G. Kittle, Chairman of the association, testified that lenders originating FHA loans need more rigorous licensing and registration requirements, as well as net worth and minimum bonding requirements. “Net worth requirements serve to assure that a originator has a stake in the industry,” he said.

David H. Stevens, Assistant Secretary for Housing and FHA Commissioner, conceded that the agency expects higher losses than previously estimated. He noted that the FHA has not loosened its underwriting standards and in fact has experienced a significant improvement in credit quality of newly insured borrowers, from an average FICO score of 633 two years ago to 693 today. He wants to hire the agency’s first Chief Risk Officer. He’s also boosting net worth requirements of mortgage originators from $250,000 to $1 million. I also understand the FHA is changing some of its terms for borrowers, for example, not letting them roll their closing costs onto the balance of the loan, a trick that further reduced their equity in the home.

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