Rolfe Winkler

A must-read opinion from yesterday’s WSJ about the expansion of federal backing for home mortgages:

Only last week, Ginnie [Mae] announced that it issued a monthly record of $43 billion in mortgage-backed securities in June. Ginnie Mae President Joseph Murin sounded almost giddy as he cheered this “phenomenal growth.” Ginnie Mae’s mortgage exposure is expected to top $1 trillion by the end of next year—or far more than double the dollar amount of 2007….

Ginnie’s mission is to bundle, guarantee and then sell mortgages insured by the Federal Housing Administration, which is Uncle Sam’s home mortgage shop. Ginnie’s growth is a by-product of the FHA’s spectacular growth. The FHA now insures $560 billion of mortgages—quadruple the amount in 2006.  Among the FHA, Ginnie, Fannie and Freddie, nearly nine of every 10 new mortgages in America now carry a federal taxpayer guarantee.

The private mortgage lending business has collapsed, especially considering that most large private lenders now operate with a government guarantee.  This is bad news for existing homeowners and banks, who are very much invested in real estate, either directly or as collateral.  Home prices are a function of the credit that’s available to finance transactions.  No credit would mean much lower house prices, even from today’s “depressed” levels.  This, we’re told, is untenable.  If house prices are allowed to fall too far, the financial sector would quickly collapse and the economy would follow.

So the government is propping up prices by providing MORE financing than it did previously, as you can see in the explosion of FHA lending.  Unfortunately, these loans are of poor quality…

The FHA’s standard insurance program today is notoriously lax. It backs low downpayment loans, to buyers who often have below-average to poor credit ratings, and with almost no oversight to protect against fraud.

The piece mentions a report from HUD’s Inspector General which noted the FHA doesn’t have the resources to handle the explosion in lending, that it’s putting the integrity of Ginnie Mae paper at risk.

On June 18, HUD’s Inspector General issued a scathing report on the FHA’s lax insurance practices. It found that the FHA’s default rate has grown to 7%, which is about double the level considered safe and sound for lenders, and that 13% of these loans are delinquent by more than 30 days. The FHA’s reserve fund was found to have fallen in half, to 3% from 6.4% in 2007—meaning it now has a 33 to 1 leverage ratio, which is into Bear Stearns territory. The IG says the FHA may need a “Congressional appropriation intervention to make up the shortfall.”

Sound familiar?  Bad home loans are being made with taxpayer money, but because they are packaged in securities that themselves are explicitly guaranteed by the government, the lenders at the other end couldn’t care less.  So they keep lending money with no regard for risk.  How well did this work out with Fannie and Freddie?

In the wake of the mortgage meltdown, most private lenders have reverted to the traditional down payment rule of 10% or 20%. Housing experts agree that a high down payment is the best protection against default and foreclosure because it means the owner has something to lose by walking away. Meanwhile, at the FHA, the down payment requirement remains a mere 3.5%. Other policies—such as allowing the buyer to finance closing costs and use the homebuyer tax credit to cover costs—can drive the down payment to below 2%.

A tax planner e-mailed me a few weeks back, noting how many folks were re-filing last year’s tax returns to take advantage of the first-time home buyer tax credit.  With the help of an FHA loan, this allows them to put almost no money down to buy a house.

So expect high default rates to continue.  And expect taxpayers to write more very large checks to finance the losses.