We�re Addicted to Denying our Addiction to FHA�s Mortgage Crack

The recent news about the 78 year-old Federal Housing Administration (“FHA”), being the next multi-billion dollar bailout and requiring $78 billion, has many implications and everyone should pay attention as the story develops, because we’re all sure to learn a lot… about a lot more than just the FHA.

And who knows… if enough people come to understand what’s really been going on these last four years, it could be the beginning of the end of our government’s ability to convince a large percentage of the public that things are getting better all the time by using fleeting stimuli, and extend and pretend accounting tricks.

I started down this path the other day when I wrote an article that questioned how it could be that FHA’s losses were publicly being blamed on “the economy,” while Fannie’s losses were only ever talked about as being the result of bad loans… you know… the kind made to bad borrowers… by bad lenders.  (You’ll find it HERE.)

But then last week, John Griffith, a housing team policy analyst at the Center for American Progress, wrote an article for American Banker titled: “Don’t Be Fooled by the FHA ‘Bailout’ Hysteria.”  And although I don’t know John personally, his arguments in support of FHA’s lending practices while predictable, were at the same time so deliciously goofy that at times reading them made me want to get up and do one of those dances I see NFL players do after scoring a touchdown.

After finishing Griffith’s article I realized that I could use what he had to say to authoritatively fill in a few more of the blanks in the picture I’ve been trying to paint for some time now.  Because it’s important that people know what’s really been going on in our housing markets… and what’s ahead as a result.

Understanding FHA’s latest report with Ed Pinto…

Edward J. Pinto, a former EVP and chief credit officer at Fannie Mae and now a resident fellow at the American Enterprise Institute, has almost certainly studied the FHA more closely than anyone in the country these last few years.  His analysis leaves little question that this year’s report is “cause for significant concern for Congress and taxpayers.”  To put the topic into a proverbial nutshell, Pinto says the following…

“Each year the FHA gives Congress a report saying–don’t worry, next year will be better.  But each year it gets worse.”

Last week, the FHA released its actuarial study for Fiscal Year 2012 and the most salient point is that even though FHA is permitted to employ accounting rules that no other financial entity would ever be allowed to use when reporting losses… rules that some might see as approaching financial alchemy… it’s entirely insolvent and steadily deteriorating in terms of its financial condition.

Pinto explains that just as has been the case in past years, FHA’s report this year, once again “materially misrepresents the facts.”  For example, this year’s report used Moody’s interest rate forecast from last July, which projected the rates of 10-Year Treasuries to increase to 4.59% by 2014, in order to determine that the agency has a negative economic value of $13.5 billion for 2012.

(Just so everyone understands, the term “economic value,” is determined by calculating the difference between FHA’s expected insurance revenues and the agency’s expected costs resulting from defaults of underlying mortgages.)

But even the $13.5 billion negative value, Pinto says, “represents a deterioration of $23 billion from last year’s projection for FY 2012.”

However, the July forecast used by the report became entirely obsolete in September when the Fed announced that it would continue its quantitative easing programs indefinitely and today’s rate for 10-Year Treasuries is 1.57%.  Had the FHA replaced the July forecast with the low interest rate scenario that applies today, the report would show the economic value of the FHA to be negative $31 billion.

“The hole keeps getting bigger while FHA’s cash reserves dwindle,” Pinto explains.  “No matter how bad things get today, FHA continually paints a rosy picture.   The SEC would be all over a public company that played by FHA’s rules.”

 

Pinto points out that were the FHA to employ Generally Accepted Accounting Principles (“GAAP”), then FHA’s estimated current net worth is negative $26 billion as of today, and based on FHA’s 2% capital requirement, the agency has a capital shortfall totaling $47 billion.

Pinto also points out that as of today, one out of every six FHA loans is at least 30-days delinquent and that the FHA’s cash position is likely to be wiped out within the next 12-18 months.

“We must know what the FHA’s true financial condition is.  It is unacceptable to state once again, not to worry, next year things will get better. We cannot continue operating an agency with $1.1 trillion in obligations on rosy scenarios, states Pinto.”

 

We can’t?  Well, that sort of thinking might come as a surprise to some in the Treasury Department, as it seems like many there are of the mindset that they can run the entire nation on rosy forecasts, but okay… if Ed says we can’t… then at least we probably shouldn’t.

Bailout Billions seen as a Bargain?

John Griffith’s article, however, is warning us not to get caught up in FHA bailout hysteria.  He says that even if taxpayers have to bail out the FHA to the tune of $16.3 billion, which is the estimate in FHA’s report, it’s a bargain and we should pay it with glee because it’s “a small price to pay for the agency’s efforts to rescue the housing market.”

The FHA rescued the housing market?  Well, if that’s true then it did a damn lousy job, but that’s not really what Griffith meant.  He said…

“Without the agency’s help in recent years, it would have been much more difficult for middle-class families to access mortgage credit since the housing crisis began. As private capital fled the mortgage market, FHA insurance propped up demand for homes, preventing housing construction and sales from plummeting even further than they did.”

 

Wasn’t that last sentence a goose-bumper?  FHA “propped up demand for homes,” and prevented new construction and sales “from plummeting even further than they did.”

Now, everyone’s been saying that housing markets are coming back, but Griffith is now saying that it’s been the FHA driving the demand all along, and that without the agency to insure loans, we’d be in much worse shape than we are now.  And get this…

“According to Moody’s Analytics, the agency’s actions prevented home prices from dropping an additional 25%, which in turn saved 3 million jobs and half a trillion dollars in economic output.”

 

Okay, let’s just pause for a moment right here…

What Moody’s is saying is that FHA kept financing available in our housing markets when private investors fled the mortgage-backed securities and CDO markets back in 2007.  Now, I’ve written extensively about this issue, so my regular readers should be hearing bells go off all over the place.

(If you haven’t read my articles on this topic, you should read HERE and HERE at least.)

Private investors fled because they no longer trusted the ratings that had been placed on mortgage-backed securities and when stopped investing in these debt securities, almost overnight homeowners found it was impossible to get a mortgage or refinance one as banks started hoarding cash… and that threw the prices of homes into a free fall.

By the time our government realized what was happening and was able to take any action to mitigate the damage it was too late… prices had fallen so fast and so far that millions of homes were now underwater, that is to say, worth less than the amounts people owed on them.

Paulson, Bernanke & Bair, oh my!

The only option was for the government to become the lender of first and last resort, there simply wasn’t any other source of capital in the lending game anymore.  Fannie and Freddie were insolvent and they were taken over by the government when placed into conservatorship, under control by their regulator the FHFA.  They could be part of the solution, but not nearly all of it because the FHFA’s mandate was to return the GSEs to profitability, so their criteria for loaning money was and is fairly stringent.

The FHA, on the other hand, was the only answer we had to keep loans going because as an agency of the federal government there are no investors to report to, it’s only us taxpayers that are going to pick up the tab when loans go bad.  We’re the “investors” in the FHA’s pools, if you will.

So, the FHA became the “new sub-prime.”

It could approve loans with 3.5 percent down payments, which is a heck of a lot easier to come up with than the 20 percent Fannie required.  And the credit score needed to get an FHA loan was relatively lower too… as opposed to the 700 plus at Fannie or Freddie post 2009.  There were even programs that would do away with the need to put any money down on an FHA loan, called “seller funded down payment assistance.”

And so here we are… the end of 2012 and one out of every six FHA loans is delinquent or in default.  It’s fast approaching 20 percent, and FHA is going broke.  Isn’t it lucky that it’s only the American taxpayer that’s on the hook for the losses… tens of billions in losses today… and I’d bet much more tomorrow.

You see, we didn’t fix anything since our economy fell off a cliff in 2007.  We just got a new crack dealer to keep the sub-prime mortgage machine alive and well… on the backs of the country’s taxpayers instead of private investors who wanted nothing to do with it anymore.  Read that Moody’s forecast from above again…

“According to Moody’s Analytics, the agency’s actions prevented home prices from dropping an additional 25%, which in turn saved 3 million jobs and half a trillion dollars in economic output.”

 

Without our new sub-prime crack dealer, home prices would have dropped another 25 percent.  And now that FHA is insolvent, it will have to tighten its lending standards and raise its premiums… and as its loans become harder to get… what will happen next?

Well, prices will return to falling because what stopped them from falling wasn’t the fundamentals of the housing market… it wasn’t a function of supply or demand.  It was a government distortion created by a federal agency disregarding everything else in order to continue doing what got us into this mess in the first place.

That’s right… as incredible as it sounds, we’ve actually been knowingly manufacturing foreclosures, because the bulk of the defaulting loans at the FHA today are from loans made from 2007 forward, with a significant portion coming from loans made after 2009.

We needed more crack… meaning we needed to make loans to people with low credit scores and no money for a down payment.  So we made the loans guaranteed by the FHA… and now it’s time for taxpayers to pick up the tab… as home prices commence their free fall.  Crackerjack work, fellas… absolutely crackerjack.

That’s why there should be a warning label on all FHA loans that says: WARNING!  20% of these loans end in foreclosure within the first five years.  Proceed at yours and the American taxpayer’s risk.

Oh, one more thing while we’re here…

Why is it so important that we do something to stop this free fall… this foreclosure crisis?  Check the Moody’s quote one more time.  Home prices dropping another 25 percent would cost 3 million jobs and half a TRILLION in economic output.  And although it stops there, how many foreclosures would the loss of three million more jobs create?  How about if we agree that it would be quite a few and leave it at that?

And how much further would home prices fall as a result of those additional foreclosures?  And how many more people would be under water as a result of those 3 million jobs being lost?  And that would create more foreclosures still, right?

So, yes… Griffith is right about the FHA being used to “prop up the housing market.”  The problem is propping up is useless unless you’re going to fix what’s broken while you’re propping up.  Otherwise when you stop propping it just starts falling again.  Just think “Cash for Clunkers,” and you’ll get the idea in a condensed version on the same theme.  When the program ends everyone stops buying cars again.

(Oh, and speaking of new car sales… the automakers are doing pretty well, have you noticed?  Want to know why in our anemic economy why that would be the case?  If you guessed plenty of sub-prime loans available, you’d be right.  FICO of 520… a grand down… no problem… you’re in.)

That’s the problem with stimulus… it all ends eventually.

When a junkie is sick, there are two ways to cure the sickness.  1. Get the junkie more heroin and he or she will be up and around in no time.  2. Get him or her off heroin by checking him or her into a detox center.  Sure, it’s a lot easier to just hand over more heroin, but it doesn’t really solve your problem, now does it?  Maybe for a day or two, but after that, however, you’ve got a sick junkie on your hands again.

And speaking of sick junkies, how many times do you suppose the EU will keep bailing out Greece… or Spain… or Portugal… or Ireland… are you getting the picture?

We’re not fixing anything.  We’re papering over problems and telling people everything’s fine even though it may not feel that way.  It’s a jobless recovery, don’t you know. Well from now on we should make it clear that we don’t want one of those.  We’re only interested in the kinds of economic recoveries that come along with jobs.

We’ve spent more money on financial Band Aids than any nation in the history of the world and we’ve solved nothing.  Well, I guess we’ve made FHA insolvent, there is that.

It was probably worth it though, because although bankrupting FHA may not have fixed anything… and although it may have created more foreclosures… and raised the deficit… it did help Obama get reelected, so it was worth it, right?

Just consider what Griffith says in his article, and in no uncertain terms…

“… the agency’s current financial troubles are not the result of a weak business model or the financial incompetence of federal bureaucrats, but of a “hundred-year flood” of  foreclosures during the worst housing crisis since the Great Depression, plus a couple of poor policy decisions.”

 

And this kid is a “policy analyst” at the Center for American Progress?  A “hundred year flood” of foreclosures?  These guys and their technical jargon…

Of course the losses are a product of a weak business model and the incompetence of federal bureaucrats… but none of that matters… we just need the crack baby.

The real point of Griffith’s article is that we shouldn’t be taken in when critics of the FHA start screaming “bailout,” rather we should recognize how horrible our economy and housing market would be without the FHA, and therefore we taxpayers should be happy to pick up the tab for the agency’s sub-prime mortgage crack that’s producing close to 20 percent defaults.

“Meanwhile, the agency’s more recent years of business are likely to be some of its most profitable ever, due in part to higher fees and new protections put in place by the Obama administration. It’s worth noting that roughly 70% of loans made since 2010 – the “profitable” books – had a down payment of less than 5%, so the agency’s basic business model still appears to work.”

 

Down payments of less than 5% since 2010 means most of those people are underwater today… and as such they’re set up to fuel a next wave of foreclosures.  Why our policy analyst friend seems to feel that’s proof of something working, is beyond me, but I don’t want to spend any time figuring out why he thinks the way he does because I’m scared my brain will stay that way.

Besides, I think he said enough.  And he’s certainly not the only “policy analyst” who makes very little sense when talking about the ongoing meltdown of our housing markets, so I’m not really trying to pick on him.

And make no mistake about it… none of this should be “news.”  Lots of people have been warning that FHA was becoming insolvent for well over a year.  Joseph Gyourko of the American Enterprise Institute, as just one example, wrote a report over a year ago that raised the question, “Is FHA the Next Housing Bailout?”

Gyourko’s 2011 report concluded that FHA’s main insurance fund was already broke at that time and “would need a $50–100 billion capital infusion to put the program on a sound financial foundation.

And so, after being warned that sort of thing was coming… predictably our government sunk into inaction, promptly did absolutely nothing, and now our elected representatives are standing around trying to feign a look of surprise, and most assuredly hoping that the subject proves too boring for most to focus on and therefore truly understand.

I’ve said it before and I’ll say it again… we’ve lost the ability to swerve in order to avoid collisions.  Metaphorically speaking, we have to hit the iceberg… fall off the cliff… watch the Twin Towers fall to the ground… before we can even try to change anything.

And so the beat will go on.

Treasury will write a check for an amount much higher than anyone thought to save the FHA, and the blame for the bailout will go to the economy as defaults and therefore costs continue to mount.

FHA will increase its premiums and tighten its lending criteria, but ultimately it won’t be able to grow itself out of its fiscal shortfalls. Ultimately we’re going to have to get off the crack.  Ultimately we’re going to have to actually fix things that are so clearly broken, and those that profit from the way things are won’t like that one bit.

You just can’t lose money on every deal and expect to make it up on the volume… even as a federal agency.

What kills me is how many hundreds of billions we’re going to have spent around the foreclosure problem, and how little we’ll spend directly on it.  And all because we can’t seem to explain to enough people in this country that it wasn’t “irresponsible borrowers” that caused the crisis… that Rick Santelli is nothing but a blowhard… and that we should all want foreclosures to stop… because we can’t afford to do anything else.

Mandelman out.