About to Get Blindsided Again

For the majority of regulators, policymakers, and financial industry insiders -- who really should have known better -- the meltdowns at Fannie Mae and Freddie Mac kind of snuck up on them, like pickpockets working a crowd of clueless tourists.

(Image source: http://mydayonthej.blogspot.com/2008/11/wheres-my.html)

Naturally, you would have thought they had learned from the experience. Unfortunately, that is not case. In a commentary entitled "The Next Fannie Mae," the Wall Street Journal suggests the still-oblivious  -- not to mention U.S. taxpayers -- are about to get blindsided again.

Ginnie Mae and FHA are becoming $1 trillion subprime guarantors.

Much to their dismay, Americans learned last year that they “owned” Fannie Mae and Freddie Mac. Well, meet their cousin, Ginnie Mae or the Government National Mortgage Association, which will soon join them as a trillion-dollar packager of subprime mortgages. Taxpayers own Ginnie too.

Only last week, Ginnie 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. (See the nearby table.) Earlier this summer, Reuters quoted Anthony Medici of the Housing Department’s Inspector General’s office as saying, “Who would have predicted that Ginnie Mae and Fannie Mae would have swapped positions” in loan volume?

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.

Herein lies the problem. 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. Sound familiar? This is called subprime lending—the same financial roulette that busted Fannie, Freddie and large mortgage houses like Countrywide Financial.

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.”

The IG also fears that the recent “surge in FHA loans is likely to overtax the oversight resources of the FHA, making careful and comprehensive lender monitoring difficult.” And it warned that the growth in FHA mortgage volume could make the program “vulnerable to exploitation by fraud schemes . . . that undercut the integrity of the program.” The 19-page IG report includes a horror show of recent fraud cases.

If housing values continue to slide and 10% of FHA loans end up in default, taxpayers will be on the hook for another $50 to $60 billion of mortgage losses. Only last week, Taylor Bean, the FHA’s third largest mortgage originator in June with $17 billion in loans this year, announced it is terminating operations after the FHA barred the mortgage lender from participating in its insurance program. The feds alleged that Taylor Bean had “misrepresented” its relationship with an auditor and had “irregular transactions that raised concerns of fraud.”

Is anyone on Capitol Hill or the White House paying attention? Evidently not, because on both sides of Pennsylvania Avenue policy makers are busy giving the FHA even more business while easing its already loosy-goosy underwriting standards. A few weeks ago a House committee approved legislation to keep the FHA’s loan limit in high-income states like California at $729,750. We wonder how many first-time home buyers purchase a $725,000 home. The Members must have missed the IG’s warning that higher loan limits may mean “much greater losses by FHA” and will make fraudsters “much more attracted to the product.”

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%.

Then there is the booming refinancing program that Congress has approved to move into the FHA hundreds of thousands of borrowers who can’t pay their mortgage, including many with subprime and other exotic loans. HUD just announced that starting this week the FHA will refinance troubled mortgages by reducing up to 30% of the principal under the Home Affordable Modification Program. This program is intended to reduce foreclosures, but someone has to pick up the multibillion-dollar cost of the 30% loan forgiveness. That will be taxpayers.

In some cases, these owners are so overdue in their payments, and housing prices have fallen so dramatically, that the borrowers have a negative 25% equity in the home and they are still eligible for an FHA refi. We also know from other government and private loan modification programs that a borrower who has defaulted on the mortgage once is at very high risk (25%-50%) of defaulting again.

All of which means that the FHA and Ginnie Mae could well be the next Fannie and Freddie. While Fan and Fred carried “implicit” federal guarantees, the FHA and Ginnie carry the explicit full faith and credit of the U.S. government.

We’ve long argued that Congress has a fiduciary duty to secure the safety and soundness of FHA through common sense reforms. Eliminate the 100% guarantee on FHA loans, so lenders have a greater financial incentive to insure the soundness of the loan; adopt the private sector convention of a 10% down payment, which would reduce foreclosures; and stop putting subprime loans that should have never been made in the first place on the federal balance sheet.

The housing lobby, which gets rich off FHA insurance, has long blocked these due-diligence reforms, saying there’s no threat to taxpayers. That’s what they also said about Fan and Fred—$400 billion ago.

Comments

[HSpencer]

All mortgage bankers should limit loan payments to 30% of a borrower's adjusted gross monthly income. How many $725,000.00 houses would THAT sell for the Realtwhores?

[Whatever]

This mess really pisses me off! Congress is useless. and this financial mess we find our country in exposes them every single day.

[Arnold]

So what will happen is some Congressman will grill the FHA or Ginnie Mae heads in a hearing to make it appear they are looking out for their constituents. Nothing could be further from the truth.

Where exactly was Congress these past years when all this was going down?
The likely answer is too busy meeting with lobbyists, having an affair or "socializing" in a public toilet.

TERM LIMITS & PUBLIC FINANCING OF ELECTIONS!

[Rocky]

During the past few months, I have seen financial articles referring to FHA mortgages being available with 3% down payments. Sounds like deja vue all over again. Blessed are the children, for they shall inherit the national debt.

[Morocco Bama]

I don't believe this a matter of "blindsided," as you say. They know damn well everything they are doing amounts to kicking the can down the road. The problem is the can's being kicked uphill, and it's size has reached astronomical proportions. There's no road left and the can's about to roll back on us, but no matter for the elite and their stooges in Washington......they can cloister themselves in their private enclaves and allow us to do their laundry for a piece of bread. NeoLiberalism is NeoFeudalism just as surely as Soylent Green is People. This go around the serfdom will be permanent.

[jturner]

I agree with Morocco Bama. I think that the govt has demonstrated that they are going to continue to throw money at these failed institutions to try to clean up their mess. This will continue to have negative consequences for our currency, as their main remedy for all of these problems is money printing and stimulus, which is essentially debt.

And since those people who actually want to fix the problems are not in charge and the govt has a one track mind of more debt, one of the only ways for most people to protect and potentially prosper from this is by investing in those assets that should rise from all the money printing, such as gold and other commodities. Here is a good discussion on a gold mining company, Premier Gold that should benefit from a rise in the gold price. It is unusually well-diversified for an exploration company and doesn't contain the same risks as many other junior miners that possess a single project.

[jturner]

Sorry, link to article did work in last comment. Here it is again: http://www.goldalert.com/stories/Premier-Gold-Intersects-Target.php