Another Government Mortgage Entity Is Blowing Up
Everyone knows about the troubles at Fannie and Freddie, but the Federal Housing Administration has gotten a lot less attention even though it has had by far the most dramatic change in behavior since the implosion of the lending market. The Wall Street Journal has the goods on [one of] the next bailout[s].
The FHA insures private lenders against defaults on certain home mortgages, an inducement to make such loans. Insurance from the New Deal-era agency has enabled lending to buyers who can’t make a big down payment or who want to refinance but have little equity. Most private lenders have sharply curtailed credit to those borrowers. In the past two years, the number of loans insured by the FHA has soared and its market share reached 23% in the second quarter, up from 2.7% in 2006, according to Inside Mortgage Finance. FHA-backed loans outstanding totaled $429 billion in fiscal 2008, a number projected to hit $627 billion this year…
Policymakers have used the FHA to stabilize the housing market by pushing it to offer credit with far easier terms than that offered by most private lenders. For example, it will back loans with down payments as low as 3.5%.
In essence, the mortgage market currently is nearly completely dominated by conforming mortgages that are sold to Fannie/Freddie (which are GSEs, technically private but implicitly backed by the government) or other mortgages that may remain on the books of lenders but are insured by FHA. In either case, it’s offloading risk from private companies that are making the decisions and onto the government.
Some economists say the FHA’s lending has been crucial to preventing a deeper bust in property. Thomas Lawler, an independent housing economist, said “the alternative could have been a complete meltdown of housing finance” that would have ultimately led to much larger losses. Critics have said the FHA, which has never had a chief risk officer, isn’t able to manage such a large portfolio in an unstable market.
The reason why no one really talks about this is that the FHA is supposedly self financed through insurance premiums, but just like the FDIC, those premiums are proving to be insanely underwhelming. In fact the whole point of the article is that they may fall under the 2% threshold mandated by Congress (by contrast the FDIC is supposed to maintain 1.5% and is currently at 0.22%). Foreclosures won’t peak anytime soon and indeed there is a record amount of houses that are already in the pipeline, which is going to make prices start to plummet again. Moreover (sorry I couldn’t find the link) the delinquency rates from mortgages less than two years old are even higher than the peak years of the bubble! Taking these two issues into account, it will be very surprising if the FHA needs less than $100 billion.
Whether it’s Fannie/Freddie or the FHA/FDIC, it is becoming increasingly clear that when the government tries to have its cake and eat it too, things don’t work. The purpose of this arrangement to keep all the assets off the government balance sheet and thus hide how much they are really covering. However, this leads to “regulatory capture” which means that the people in charge of oversight become beholden to the interests of the people they are overseeing. If you add up all the expected losses by all the various government backed agencies (what has been discussed here plus the Fed) that will be realized if the default rates rise to levels projected by the credit agencies S&P/Moody’s/etc. then the government will be on the hook for somewhere between $2-3 trillion — all with barely any authorization by Congress. What Congress has authorized was done under the pretense that there would be nearly no cost for doing so because the programs would be self financed or make the economy grow.
This is why the government is trying everything they can to keep asset prices up, and expect to see many more tax credits and other programs coming down the pipe at the cost of tens or hundreds of billions. At best this will merely enable the financial giants to suck the rest of the economy dry and we will see continued incompetence rewarded and worsening income inequality and destruction of the middle class.
Update: The calls for expanding the housing credit have already begun.