“Now it’s the FHA – Will We Ever Learn?”

Sydney M. Williams

Thought of the Day

“Now it’s the FHA – Will We Ever Learn?”

November 26, 2012

Since entering conservatorship in September 2008, $188 billion in taxpayer funds have been used to prop up Fannie Mae and Freddie Mac. Granted, the two companies have repaid $45 billion in dividends to the Treasury, but most of the funds used to pay those dividends were borrowed from the Treasury. It was simply a matter of taking a roll of bills from one’s left pocket and placing it in the right – a slight-of-hand unavailable to most taxpayers. In sharp contrast to a shell game, it is the dealer who plays the fool.

Ten days ago, the U.S. Department of Housing and Urban Development (HUD) released its annual report to Congress on the financial condition of the Federal Housing Administration (FHA) Mutual Mortgage Insurance (MMI) Fund. The independent study found that, even as housing continued to recover, the capital reserve ratio of the MMI Fund, which is used to support FHA’s single family mortgage insurance programs, fell below zero to a negative 1.44% – or a negative economic value of $16.3 billion. The HUD report also includes “additional actions designed to contribute billions of dollars in added value to the MMI fund over the next several years.” Among those are hiking mortgage insurance premiums, selling off delinquent loans, and pressuring five major banks to contribute another $500 million into the capital reserve fund. Taxpayers and banks are being asked to pay for the FHA’s actuarial losses.

The FHA is the largest insurer of mortgages in the world, providing lenders protection against losses incurred in the case of default. It currently insures about 4.8 million homes and 13,000 multi-family units, with a value just under $700 billion. The Agency was established in 1934, becoming part of HUD in 1965. Its mission is to insure mortgages for low-income and first-time buyers. According to the HUD website, the “FHA is the only government agency that operates entirely from its self-generated income and costs the taxpayers nothing” – a dubious statement, in light of its just-released annual report. Unlike conventional loans that adhere to strict underwriting standards, FHA-insured loans require very little cash down, generally about 3.5%, and are made to those with credit scores as low as 580. (The Federal Reserve determines that borrowers with credit scores below 640 are subprime.) Forty percent of newer FHA-backed loans are subprime and 17% are now delinquent.

During the housing boom that peaked in late 2006, the FHA generally sat out the party. Lenders were willing to make conventional “no-doc” or “low-doc” loans to subprime borrowers. They were easy to qualify for and less expensive. Private insurers flocked to the party. But once credit tightened in 2008, FHA’s star began to ascend. The Associated Press reported in late 2009 that the number of mortgages insured in September 2008 (96,000) was three times what they had been a year earlier. A Bloomberg report of last May stated that in 2010, the Agency insured 1.1 million single family loans, versus 261,165 in 2007. Today, the FHA is insuring about 6000 loans a day (multi-family as well as single family), four times the amount in 2006.

In April, lenders initiated foreclosures on 36,400 FHA-insured mortgages, twice the number of a year earlier. Diane Swonk, chief economist at Mesirow Financial in Chicago, noted that in September 2011, 638,000 FHA mortgages were in their second default – 12% of mortgages then insured.

There are times when it becomes necessary for government to act quickly and decisively, as they did in the fall of 2008 when the credit crisis threatened to take down the financial system. But the mission of government should always be to exit the field as soon as practically possible, to reduce their direct involvement in what is better performed by the private sector. In reality (and unfortunately) that goes against the grain of politicians who do not like to be the bearer of bad news. It is in the nature of these folks to keep on giving, ergo the promise of homes for all by President’s Clinton and Bush; a chicken in every pot and a car in every garage, as Herbert Hoover promised in 1928; flood insurance for those who live along coastal plains; extraordinarily low interest rates for indebted consumers and government, and low mortgage insurance for subprime homeowners. Like Little Orphan Annie, we are promised that the sun will come up tomorrow.

Newton’s Third Law states that for every action there is an equal and opposite reaction. Likewise, it is in the nature of man to constantly be in motion. Storytellers write of the yin and the yang, and of feast or famine, of the pull of evil and the push toward good. In an interview in this past weekend’s Barron’s, Carmen Reinhart spoke of human nature as it applies to economics throughout history: “You go through history and, in good times, the tendency is to, liberalize. Then a crisis happens, and you retrench. But the retrenchment lasts only as long as your memory does and memory is not that great.” Especially for policy makers, she adds. The cause of the credit crisis was an excess of optimism as it applied to asset prices, be they homes, commodities or stocks and bonds. Prices ran up on the eons-old greater fool theory. We are now in the digestive phase.

Home values, stocks and the economy collapsed, as consumers slowed their spending. The Fed offset the decline in asset values and the rise in our national debt by greatly reducing the cost of money and cheapening the dollar. The federal government, not wanting to be seen as ignoring the crisis, put in place more regulations, created an entirely new entitlement system, (the Affordable Care Act), increased transfer payments, cut the payroll tax, and implemented dozens of new taxes to help pay for Obamacare. The consequence has been a rally in stocks, positive but mediocre GDP growth, continued high unemployment – all covered in a blanket of uncertainty.

Over the past decade and a half, Congress and regulators looked the other way when Fannie Mae and Freddie Mac used excess leverage to create high-risk portfolios. Managements of the two agencies, in conjunction with Congress, proved a vivid manifestation of crony capitalism. Congress promised homes for all, with little regard for the ability to repay loans. Managements at FNM and FRE were paid outrageous salaries, while the Agencies became huge political donors to their backers in Congress. Their de facto bankruptcies have costs taxpayers billions of dollars.

We have witnessed the same financial ineptitude in other government-sponsored programs, ranging from Sallie Mae to Solyndra. According to Friday’s Wall Street Journal, 38% of all college graduates with student loans are either delinquent or have defaulted. Taxpayers have pumped and lost billions of dollars into alternative energy companies like Solyndra, sometimes permitting politically-connected investors to come out ahead of taxpayers when the businesses defaulted. General Motors reported profits, but that was after a restructuring that cost thousands of non-union workers their jobs and reneging on obligations to bond holders. The U.S. Post Office lost $15.9 billion last year and predicted “more red ink for fiscal 2013.” (Keep in mind that about 70% of mail delivered is junk or unwanted catalogues, and that the balance represents bills and solicitations.) Bloated bureaucracies and crony capitalism have conspired to render government’s ability to efficiently manage businesses essentially nonexistent.

The Federal Housing Administration was supposed to be an exception. According to the HUD website, the FHA, as mentioned earlier, is the only government agency that operates entirely (theoretically) from its self-generated income and “costs the taxpayers nothing.” Given the extraordinary increase in their business, private insurers sensibly vacated the market, amid a vetting process that does not conform to traditional underwriting practices. It seems highly probable that the taxpayer will once again become the backstop.

Will we ever learn? Individually we might, but collectively, and in regards to our government, the answer, sadly, seems to be no – that history is doomed to keep repeating itself, and that our government appears fated to become even more pervasive.