The Coming Federal Housing Administration (FHA) Disaster

The FHA is a Government entity which was created in 1934 during the Great Depression. It was formed to improve housing standards, provide adequate home financing by insuring mortgages and stabilize the mortgage market. If these mission statement sounds familiar it is because they closely resemble the rationale behind the existence of other Government entities including Fannie Mae, Freddie Mac, Ginnie Mae, HUD, etc…

These entities directly intervene in the Housing Market by providing mortgages and subsidizing interest rates to borrowers who would not otherwise be qualified to receive such loans.

As a group the Government Sponsored Entities (GSEs) operate with the intent to increase homeownership, improve home affordability and provide mortgage market stability. Obviously they have failed miserably in each and every one of these stated goals. Amusingly, the only achievement which appears to be viable in the near term is the prospect of affordable housing, but the Government continues to misuse the GSE’s in a desperate attempt to prop up housing values and prevent that desired affordability.

Both Fannie and Freddie collapsed in 2008 because their role in the mortgage market had been expanded dramatically by the Government which used these entities as a means to achieve the social goal of greater homeownership. When the Housing Bubble inevitably deflated so did the viability of Fannie and Freddie. The Government then foolishly “doubled down” on its ill-advised housing gamble by using the entities to fill the gap in the mortgage market left by fleeing private capital. This disastrous directive only accelerated the collapse of the Fannie and Freddie and in turn further damaged the mortgage and housing markets.

Instead of learning from their mistakes, the Government has decided to execute the same playbook but this time through a manipulation of the FHA.

According to a recent WSJ report:

“Since the collapse of the subprime mortgage market in 2007, most home loans for people who can't afford a sizable down payment are flowing to the FHA. The agency, which is part of the U.S. Department of Housing and Urban Development, insures mortgage lenders against the risk of defaults on home mortgages that meet its standards. FHA-insured loans are available on loans with down payments as small as 3.5% of the home's value.

The FHA's share of the U.S. mortgage market soared to nearly a third of loans originated in last year's fourth quarter from about 2% in 2006 as a whole, according to Inside Mortgage Finance, a trade publication. That is increasing the risk to taxpayers if the FHA's reserves prove inadequate to cover default losses.”

The Government has directed the FHA to rapidly grow its operations. It now underwrites and/or purchases thirty-something percent of all mortgages issued. The FHA guarantees losses associated with these mortgages which have been extended to uncreditworthy borrowers and secured with marginal down payments. The FHA has undertaken this extraordinary expansion in the midst of the most rapid decline in housing prices in U.S. history. By definition, virtually all of the mortgages the FHA has underwritten during its three year expansion are already underwater. It is a certainty that large numbers of these mortgages will end up in foreclosure and expose taxpayers to massive financial loss.

This inevitability has already begun to materialize:

“Defaults on home mortgages insured by the Federal Housing Administration in February increased from a year earlier. A spokesman for the FHA said 7.5% of FHA loans were "seriously delinquent" at the end of February, up from 6.2% a year earlier.”

There is only one possible outcome of the Government’s unsustainable actions. The FHA will fail as massive foreclosures trigger insured liabilities which overwhelm its capital reserves. Of course I expect the Government to cry foul, incite populist furor, shift the blame to an expedient target and cavalierly allocate a few hundred billion dollars from the Federal Reserve, the Treasury or a Stimulus Bill to bail out the FHA. This is the playbook the Government has consistently relied upon to evade culpability for unconscionable abuses of its fiduciary responsibility to taxpayers.