Tuesday, November 20, 2012

It's The Economy Stupid: Housing, Building, The FHA In Deep Do Do

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The Wall Street Journal.

November 20, 2012, Page A14

The Latest Taxpayer Housing Bust

With the election over, we learn that the FHA is insolvent.


Vindication is overrated, especially in a losing cause, so it brings no satisfaction to have predicted that the Federal Housing Administration would sooner or later threaten taxpayers. That day has arrived. Safely past the election, the feds announced Friday that the FHA's liabilities exceed its assets by at least $16.3 billion—and the gap could reach $93.7 billion in the worst case.


Yet it's worth recalling that when we warned about FHA's troubles in September 2009, we got an accounting lecture from HUD Secretary Shaun Donovan and a letter from FHA Commissioner at the time, David Stevens, that we were "just plain wrong." He added that, "I can say undoubtedly that the FHA fund is playing a key role in the housing recovery and poses no immediate risk to the American taxpayer."


Taxpayers will "undoubtedly" be pleased to know that the threat wasn't "immediate" but arrived a mere three years later. Can taxpayers claw back the salaries of Messrs. Donovan and Stevens the way Congress has tried to do with those of financial CEOs?


The Administration is trying to spin the FHA's troubles as one more result of the housing bust, which is true but disingenuous. Fannie Mae FNMA 0.00%and Freddie Mac FMCC -4.44%went belly up in 2008 because of the housing boom and bust. At the time, the FHA was in relatively good shape because it had played a minor role during the housing mania.


The FHA got into trouble because it deliberately expanded in 2007-2009 even as the market was crashing. As Mr. Donovan likes to say, the FHA was steered to play "an important countercyclical role in the housing market." The point was to ramp up FHA's loan-guarantee business to prop up housing prices as much as possible during the bust.


While this helped the Obama Administration politically, it arguably prolonged the recovery by failing to let prices find a bottom. Meanwhile, FHA's boom put taxpayers on the hook for tens of billions worth of dubious loans made at the most dubious time. Those are the loans now going bust. According to the new HUD report, FHA loans insured between fiscal 2007 and 2009 "continue to place a significant strain on the [single-family mortgage insurance] Fund and are expected to reach a total of $70 billion in claims."


The ugly math: 25.82% of FHA's 2007 loans, 24.88% of its 2008 loans, and 12.18% of its 2009 loans were seriously delinquent as of June 30. The American Enterprise Institute's Ed Pinto, who also predicted the FHA debacle, estimates that 17.3% of all FHA loans were delinquent as of September 30. That's about one in six loans.


Most businesses would look at these losses and flee such a market. But the FHA, which responds to political rather than market incentives, has literally tried to make it up on volume. In recent years, the FHA has expanded to insure higher-quality loans that by law were supposed to be the preserve of private lenders.


While fewer of these loans are delinquent, the greater lending has caused the FHA's capital ratio to shrink below its 2% minimum mandated by law. In 2009, the agency had $685 billion insurance in force and a capital reserve of 0.53%. Today it has $1.1 trillion in force and capital reserves are a negative 1.44%.


The FHA says its risk models were broken, it was too optimistic about housing prices, and it didn't expect low interest rates to persist. (Low interest rates hurt FHA finances because good borrowers refinance.) If current low interest rates were used in HUD's model, the forecast losses in FHA's single-family business would be $31.1 billion, not $13.5 billion.


You will not be reassured to know that HUD claims that all of this is merely temporary. The FHA says it doesn't currently need a Treasury bailout because it will reduce its losses by raising insurance premiums, expanding short sales, selling some of its distressed loans and helping troubled borrowers modify their mortgages. That's nice, but why wasn't it doing this already?


In any case, this sunny HUD scenario will only hold if the economy grows faster and the housing market continues to improve. If there's another recession, taxpayers are looking at a Fannie Mae-level bath.


The FHA is another case study in how government programs sold with the best intentions are inevitably corrupted. FHA was founded in 1934 to help lower- to middle-income and first-time home buyers obtain a mortgage, but its mission expanded over the years as the housing lobby sought to channel ever more taxpayer-guaranteed money into housing. When the agency opened, its minimum down payment was a prudent 20%. In the 1960s, that number fell to 10%, and now it's 3.5%.


The other issue is accountability. As government program after government program fails, no one takes responsibility. Fannie and Freddie hit taxpayers for $138 billion, the Post Office loses $15.9 billion, and now the FHA is insolvent. We weren't kidding about those salary clawbacks.




A version of this article appeared November 20, 2012, on page A14 in the U.S. edition of The Wall Street Journal, with the headline: The Latest Taxpayer Housing Bust.


Copyright 2012 Dow Jones & Company, Inc. All Rights Reserved

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