If you bought or refinanced a house within the past year, there's a 1 in 4 chance you have the Federal Housing Administration to thank. The Depression-era agency, once the last resort of folks who were less-than-perfect credit risks, was practically forgotten during the real estate boom anyone with a pulse qualified for a mortgage. Now the FHA has resumed its old role by propping up the housing market, since private lenders began shunning all but the least-risky loans. The FHA doesn't lend directly but rather entices lenders do so by agreeing to cover any losses. The FHA stood behind fewer than 3% of new mortgages in 2006. In 2009, just three years later, the FHA insured nearly 30% of home purchases and 20% of refinances.
That hasn't come without cost. As the FHA filled the void left by the private sector, it has assumed the risks of those loans. And now that a growing number of people have stopped paying their mortgages, the FHA has had to pay out more in claims that it forecast. The agency has just $3.6 billion on hand to cover any unexpected losses in its $685 billion portfolio. That paltry level of reserve funding, less than is mandated by the government, has left some members of Congress in a twitchy mood and some onlookers to wonder if the FHA will eventually need a massive infusion of cash.
If Congress does wind up extending emergency funds to the FHA which is a full-fledged part of the Federal Government, unlike quasi-government bailout beneficiaries Fannie Mae and Freddie Mac it will be in large part because of the role the agency has played in stabilizing the housing market. Last spring, as first-time home buyers rushed to take advantage of the $8,000 tax credit designed to lure them into the market, the FHA insured a full 49% of their mortgages. In October, Congress renewed a higher limit on the size of FHA loans (now up to $729,750), first put in place last year, to allow the agency to expand into pricier markets. "The government may need to inject billions of dollars into the FHA, but the alternative another perturbation in the housing market, more foreclosure aid, more bank bailouts could have cost dramatically more," says housing economist Thomas Lawler.
That's not to say the FHA has been a particularly graceful savior. In October an internal audit showed that as the agency amassed market share, it did a poor job of screening the thousands of new lenders sending it loans. A review of 22 approved applications found that only one contained all the required supporting documentation.
In recent months, the FHA has suspended eight of its lenders, hired its first chief risk officer and taken other steps to beef up its controls. But some bad calls whether from a lack of resources (it has long begged Congress to fund computer upgrades) or a lack of judgment will haunt the agency for years. Loans it backed in 2006 and 2007 are souring at a particularly high rate because of seller-financed down payments; when a home buyer isn't the one ponying up equity, there is more than twice as much chance that the loan will go bad. That practice is now gone, but the FHA is still expecting more than 20% of the loans it insured during those two years to eventually default.
A good chunk of the FHA's portfolio, though nearly 40% is made up of loans written over the past 12 months. In a way, that's a boon, since lenders have tightened their standards and as a result have sent higher-quality loans to the FHA. During the housing boom, more than a third of the loans the agency insured went to subprime borrowers; today, fewer than 5% do.
Still, the FHA is facing the same economic headwinds as every other mortgage-industry player. As unemployment rises, so do mortgage delinquencies. As of the end of June, nearly 8% of FHA loans were seriously delinquent or in foreclosure, according to the Mortgage Bankers Association mirroring the rate for mortgages overall. Nearly 17% of agency loans were at least 30 days behind.
And there are scenarios in which even more recent loans could be bigger trouble than anticipated. For its annual actuarial review, which the agency delivered to Congress on Nov. 12, the FHA asked its outside auditor to run a series of doom-and-gloom scenarios including one that assumes house prices continue to slide and unemployment hits 12.5%. Only in the most dire, and unlikely, of such simulations does the FHA run out of money to cover its losses, which is why FHA commissioner David Stevens has repeatedly said the agency will not need to ask Congress for money.
Former Fannie Mae executive Ed Pinto, who has testified before Congress on the state of the FHA, is not so certain. He holds that there are a number of other variables that could materially change the amount that the FHA will need to pay out in claims. For instance: how much money the agency can recoup from foreclosed properties, the growing social acceptability of borrowers' walking away from their houses and the chances that the riskiest loans in the market are finding their way to the FHA since it requires only a 3.5% down payment. Comparing FHA loans with a subset of those made by Fannie Mae (not a perfect analogy, considering that the FHA pretty much backs only 30-year fixed-rate loans), Pinto figures that the FHA will ultimately need tens of billions of dollars of outside funding to help cover its losses.
The bigger question looming over the FHA, though, is this: At what point does a federal housing agency start to pull back and force private players to resume responsibility for the loans they make? The FHA was founded in 1934 as a way to extend the prospect of homeownership to people who wouldn't otherwise be able to afford it. The agency's low down-payment requirement itself the subject of some controversy is designed to help deserving if underqualified people get a foothold in property ownership. The FHA was never meant to be the primary way America finances its home-buying. As it did in other times of real estate stress, the FHA steps in when needed. But now it might be time to start talking about an exit strategy even if that means fewer people wind up buying homes.