F.H.A. on Path to Taxpayer Bailout

From the New York Times, Housing agency's cash reserves down sharply:

The Federal Housing Administration, the government agency whose loan-insurance programs have become a crucial source of support for the housing market, said on Thursday that its cash reserves had dwindled significantly in the last year as more borrowers defaulted on their mortgages.

The agency released an audit that spelled out the rapid deterioration of its finances. It is tightening loan standards in hopes it will not become another drain on the United States Treasury, but is reluctant to clamp down so much that it snuffs out the tentative recovery in housing.

How successfully the agency walks this tightrope could well determine whether the recovery gathers force, or whether home prices slide again — perhaps creating a fresh economic downturn.

I smell trouble. The FHA, since the start of the housing crisis, has taken on the role of "lender of last resort". By insuring lenders of any potential defaults, the FHA is incentivizing risky loan underwriting. This is exactly what got us into this mess in the first place. Fannie Mae and Freddie Mac have already turned into black holes for taxpayer money, and you can rest assured that the FHA is next.

Still, Mr. Donovan stressed that the agency, which had a role in one out of five home purchases in the last year, would not need a direct taxpayer bailout.

Right.

The F.H.A.’s annual audit was scheduled for release last week, but was mysteriously delayed at the last minute. On Thursday, as it released the document, the agency explained that it wanted its auditors to include more negative forecasts as a way of understanding the worst-case risk.

The audit showed reserves to be 0.53 percent of the total portfolio, far below the 2 percent minimum mandated by Congress and far less than the audit last year had forecast. In 2007, just before housing prices began their worst slump in decades, the reserves were above 6 percent.

Ann Schnare, a consultant who has analyzed the F.H.A. balance sheet, put the situation this way: “They’re running on empty.”

The FHA simply doesn't have the capital to support the loans they are insuring. Their reserves are already well below last year's level of 3%, and are falling fast. You can think of the FHA as the new subprime lenders, as they only require 3.5% down payments on loans to primarily first-time homebuyers. The FHA is going on the assumption that a severe downturn, defined as 12.5% unemployment, has a 1% chance of occurring. We are already at 10.2%, which is a level that almost no one saw coming at the beginning of the year. Once we hit 12.5% unemployment, the pace of taxpayer bailouts will accelerate, housing will get crushed, and this depression will really start going into high gear.