Saturday, November 17, 2012

Housing Crisis Not Over—another Bailout?

A new crisis is looming in the housing/mortgage industry when the worst seems to have passed for Fannie Mae and Freddie Mac. Those two GSEs (government sponsored enterprises) were the mortgage guarantors that were principal culprits in inflating the housing bubble. Since problems arose with Fannie and Freddie, FHA (Federal Housing Administration) has grown explosively and exhibits some of their same underwriting weaknesses. For example, most conventional lenders require downpayments of 10 to 20 percent, but FHA requires only a 3.5 percent downpayment by applicants with credit scores of 580 or higher. Its minimum credit score has been 500, compared to 620 for most conventional lenders.

FHA apparently learned nothing from the failures of Fannie and Freddie. Most of its losses now come from loans made as the housing crisis deepened. About a quarter of the mortgages it guaranteed in 2007 and 2008 are seriously delinquent. It has more delinquent loans than either Fannie or Freddie even though it guarantees fewer mortgages than either of them. It now has 739,000 loans 90 days past due or in foreclosure, which is 100,000 more than a year ago.

As I pointed out in my recent book, The Impending Monetary Revolution, the Dollar and Gold, which has a chapter dealing extensively with this issue, “An annual audit released to Congress for FHA's fiscal year 2011, which ended September 30, 2011, shows FHA is nearly insolvent. By federal statute, the agency should have a minimum 2 percent capital reserve ratio. That requirement has not been met for three years, the latest ratio being 0.24 percent, the lowest in FHA's 77-year history. With allowances for projected losses, FHA had a mere $2.6 billion in reserve on September 30, 2011, for the nearly $1 trillion in mortgages its insures.”

The situation has continued to worsen. FHA's capital reserve ratio has slipped from 0.24 percent to 0.125 percent, and it mortgage guarantees have increased from “nearly $1 trillion” to $1.08 trillion. FHA's annual audit, released November 16, 2012, shows the agency's cash reserves aren't enough to cover its projected losses from delinquent loans, raising the prospect it will require a bailout.

Actually, FHA wouldn't even need to ask Congress for funds, because it has a “permanent and indefinite” budget authority allowing it to automatically receive funds from the U.S. Treasury. In each of the past three years, the Obama administration has dismissed the idea of FHA drawing directly from the Treasury as being unnecessary. As recently as February 2012, White House forecasts showed FHA being in the red by almost $700 billion, but officials said the problem would be resolved by pending legal settlements with large banks. Instead, it now looks increasingly likely that taxpayers will have to pay for a bailout.

Government guarantees are supposed to make mortgage failures less likely. But as of last December, 31 percent of FHA loans were underwater, compared to about 22 percent of non-FHA loans; there were fewer failures without government guarantees.  Furthermore, the non-FHA loans that failed were paid for by the banks—not the taxpayers. How can FHA's mortgage program be deemed necessary and effective for safely insuring mortgages when the government for three years egregiously violated its legally required 2 percent capital reserve ratio? Neither Congress nor the administration did anything to ensure the solvency of the agency or to protect the taxpayers from mortgages losses they had nothing to do with.

FHA is not an exception. Fannie and Freddie are further evidence of the futility and counterproductivity of government intervention in the mortgage market. By the end of 2010, the financial meltdown and rising foreclosures had wiped out more U.S. homeowners than were created in the 2000-2007 housing boom. The evictions and foreclosures are still continuing. The result of all the government credit expansion for good intentions has been colossal losses and heartaches for millions of people. Once again, government efforts to to provide economic "help" and safety have been less effective than if government had stood aside and let markets operate without its interference. This lesson has wider applicability than just the housing market.