Jackson Jambalaya

The Federal Register published this announcement last week:

"A recently issued independent actuarial study shows that the Mutual Mortgage Insurance Fund (MMIF) capital ratio has fallen below its statutorily mandated threshold."

FHA is required to maintain sufficient reserves as it insures all mortgages in the FHA program used by lenders. The above language is bureaucratic gobbledygook for saying "we're broke". When a bank issues an FHA mortgage to a borrower, the federal government picks up the tab if the loan goes bust. This announcement by the government comes as no surprise to me as I wrote about this a year ago in a post about the sharp increase in first-payment defaults:

"This should come as no surprise and is scary for several reasons. FHA requires a 3.5% down payment (unless you are getting funds from down payment assistance programs such as the bond money program operated by Mississippi Home Corporation.). The FHA rates for the last few years have been low, usually below 7%. The income and assets are verified, these are not "liar" loans. Despite these guidelines that should make FHA mortgages much safer than subprime, Alt-A, and Fannie Mae no-down payment loans that have exploded the housing industry, the defaults are STILL rising to very dangerous levels.

This problem does not exist because of the economy going south as there is no reason a borrower on such a mortgage should default on the first payment. Within a day or so of the mortgage's funding, the lender contacts the employer on the phone usually to verify employment just for this reason (its a standard industry practice.). The lender reviews pay stubs, tax returns, W-2's, and bank statements. There are only a handful of reasons FHA is imploding. Fraud is being committed by the lender or borrower. Sloppy underwriting practices. FHA's cashout refinances (Until recently, a borrower could get a cash-out refinance through FHA for 95% loan to value, a recipe for disaster as the default rates on such mortgages are very high.). FHA has no minimum credit score requirement (Most of the lenders have imposed their own, however.). FHA accepts "alternative" credit if a borrower has no credit history in the form of utility payments, rent payments, etc. The appraisal guidelines are not as strict as they are for Fannie and Freddie. The mortgage insurance rates are lower.

However, the pressure to use FHA programs has been great the last few years as many mortgage companies who only originated subprime mortgagees and were facing extinction obtained FHA licenses so they could pursue subprime borrowers as FHA had easier underwriting requirements compared to Fannie Mae and Freddie Mac. Some subprime lenders entered the FHA market just to stay afloat even though they lacked any FHA expertise...

Subprime crashed. Mortgage lending not supported by the government is non-existent. Fannie Mae and Freddie Mac have turned into financial money pits with no end in sight. Now we are looking at another time bomb about to go off at HUD while we are wasting our money bailing out Citi, AIG, and every one else with a hand out for some dough. The whole mess is blowing up in the faces of the politicians who don't have a clue what they are facing nor what to do. Even now, some congressmen seek to pass a law making the now-banned FHA down payment assistance programs legal once more (see note below) even though the default rates are triple those for borrowers required to make a down payment. Strap yourselves in boys and girls, the roller coaster is about to give you some more thrills and excitement as the madness continues." Earlier post

FHA has known for some time this day would come and has been allowing lenders to tighten their underwriting guidelines for FHA. However, FHA is now stating it is going to do the same thing. The same announcement states FHA is going to make the following changes:

1. reduce the amount of seller-paid closing costs from six percent to three percent of the purchase price.
2. Institute a minimum credit-score for loans. FHA did not use credit scoring at all in insuring mortgages although private lenders did.
3. Require higher down payments from borrowers with lower credit scores. FHA currently allows minimum down payments of 3.5%. Borrowers don't even have to have a down payment if using down payment assistance programs such as Mississippi Home Corp's bond money program. Unfortunately, those loans tend to have high default rates and FHA can't afford to subsidize such lending anymore.

The shortfall was first mentioned back in November 2009 in FHA's annual audit. However, FHA is now announcing it publicly and using it as a justification for tightening underwriting standards. FHA lending accounts now for nearly half of the mortgage market so any tremor at FHA is an earthquake in the housing industry. As housing continues to stumble, expect more bailouts of Fannie, Freddie, and FHA. Nearly all of the mortgage market is supported by the federal government as private mortgage lending has evaporated. This problem will be with us for years to come.