"Foreclosure is best option for some owners"

This article from the San Diego Union-Tribune is heresy in a world that believes every home is a castle and a part of the American dream (regardless of price):

Home values have fallen so far that it no longer makes financial sense for some people to keep paying their mortgage, analysts say. Some contend that those who bought at the height of the market, using risky adjustable-rate loans with no money down, may have little to lose but their pride, especially if they have undermined their credit by missing mortgage payments.

Although loan default should be a last resort, homeowners mired in debt “are better off to just get on with it, take their credit hit today and get on with their lives,” said Mark Goldman, a real estate finance instructor at San Diego State University.

“Pull the rip cord and get out now,” Goldman said. “The next step is restoring your credit, and you can't begin the restoration process until you take your hit.
...
Marc Carpenter, a San Diego real estate agent who handles foreclosures, said it is not unusual to go to a children's soccer game and hear parents debating the merits of foreclosure.

“It has become so commonplace, people are talking about it like it's a normal thing,” Carpenter said. “People are comfortable talking about it.”
...
Economists say it is too soon to know if the housing market is bottoming out. They question whether modifications that temporarily reduce interest rates without reducing loan principal will help consumers in the long run. Most lenders and servicers are wary of reducing debt principal because they don't want to anger investors who own securities backed by mortgages.

“All of these politicians who have spent all of this time working so hard to keep people in their homes by modifying interest rates are not doing any good at all,” said economist Christopher Thornberg. “Is the key to helping them leaving them with a $600,000 debt on a $400,000 house? How many years will that take to crawl out of?”

As long as mortgage modifications lack significant principal reductions and prices continue to fall ruthless foreclosure (the ability to stay in a underwater home but choosing not to do so) will be an attractive option. In going around and reading the mortgage modification forums I am amazed at how happy some home owners are at getting minor rate reduction or a reamortization of the term of the mortgage on homes that are clearly significantly underwater. The mortgage modification "trick" might end up working out well for the lenders if they can prevent the homeowner from walking and continuing to pay on an overpriced asset. How bad things get in bubble areas will be completely dependent on just how many people realize what is in their best interest not those of the banks.

Weekly Active/Pending counts SFV & Ventura - 12/27/08

I'm going to post the weekly inventory counts for Ventura County and the San Fernando Valley as more time goes by this data set will become more useful.

San Fernando Valley:
Single Family Homes
Active 3769
Backup 365
Pending 1215

Condo
Active 1310
Backup 101
Pending 366

Ventura County:
Single Family Homes
Active 2129
Contingent 572
Pending 628
Release from Showing 303

Condo
Active 723
Contingent 187
Pending 188
Release from Showing 64

Here is one way NOT to go about getting a loan modification.

The San Francisco Chronicle had an article about a group of San Fernando Valley churchgoers who are banding together in an attempt to get their loans modified en masse because they feel like their is strength in numbers. From the article:

The startling request was Lasseigne's introduction to the epidemic of foreclosures afflicting his flock in the northeast San Fernando Valley, a working-class, heavily immigrant area where more than 8,000 homes are either in default or have been foreclosed.
In the past three months, Lasseigne and other community leaders have come up with an unusual response: They have organized more than 500 Hispanic immigrant families that are behind on their payments into teams that will seek to negotiate with banks as a group, rather than individually.
They also intend to compile detailed records of how and whether lending institutions agree to modify loans - information they say could be given to government officials in an attempt to give distressed homeowners more favorable terms.

Getting a group together for political pressure isn't the bad idea but the nature of modern mortgage finance and individual profiles of each borrower means that it is essentially random how the servicers react to any one small group of mortgages. The political pressure will be useless waste of energy. Some of the people will be able to get easily modified and some of them will be essentially impossible to get modified. In many cases it is completely out of the servicers hands as to their discretion to modify some of the mortgages. The first thing people should attempt to do when figuring out if they even have a shot at a sustainable mortgage is try and find out who owns their loan. By knowing who owns the loan and who is servicing it you can then have a clearer picture of what has worked for other borrowers with the same profile by looking at some of the loan modification resources available on the internet.

From the little I have seen regarding loan modifications the modifications given out aren't really designed to do anything other than keep the cash flowing a bit longer before the eventual foreclosure. But their is another twist to it, many of the loan modifications also have a clause that the borrower gives up their right to sue for the way to loan was originally made. So the lender gets cash flow and indemnification from future lawsuits and the borrower keeps paying for an overpriced asset.

A Home Without Equity Is Just a Rental With Debt

Housing in the New Millennium: A Home Without Equity is Just a Rental with Debt -Josh Rosner June 29, 2001

I was able to read through this paper today which was written back in 2001 and was remarkably prescient for its time. It covers the rise of home ownership rates to that point and the dangers present in the steps necessary to get home ownership rates even that far. The author was warning about issues such as relaxed underwriting standards, high consumer debt, compromised appraisal process, automated underwriting systems, low interest rates and lack of any of these to be tested in a large down cycle.

There are several interesting points made about processes that are so commonplace today such that they aren't even looked at as a major part of the problems we are facing. Here is a snippet regarding appraisals change in the late 90's:

"We have spoken with real estate-appraisers, fraud appraisers and
national appraisal organizations and have been told, almost
unanimously, that the changes in the appraisal process, over the
past decade, have jeopardized the soundness of the process and
skewed real estate prices. Of the approximately 85,000 real estate
appraisers in the country, roughly 40,000 appraisers are members
of professional societies with ongoing educational requirements,
standards and ethical codes. The remaining 45,000 are
unaffiliated and subject only to varying state licensing
requirements. Many or most regional markets have moved away
from the traditional practice of randomly assigned appraisers
chosen from organized blind pools. With the elimination of the objectivity that blind pool appraisers brought to the process, the process deteriorated. Today, appraisers are, generally, hand picked by agents and brokers and are compensated for each appraisal. The system of checks and balances that the appraisal process was created to secure has become fraught with conflicts of interest.

Both real estate agent and mortgage brokers are compensated for
“closing the deal”. In the purchase of a home, the seller pays the
agent a fee, generally a percentage of the sales price. Therefore,
the agent has incentive to increase the sale price of the home.
Similarly, in the refinancing of a mortgage, the homeowner pays
the mortgage broker an origination fee, generally a percentage of
the refinanced mortgage. The broker has incentive to increase the
appraised value of the home, thereby allowing the homeowner to
extract more equity from the home. Almost all of the appraisers
with whom we spoke stated that they have felt pressure to “hit the
bid”. Those who are unwilling to succumb to these pressures face
the risk of lost business. Unfortunately for the honest appraiser,
there always seems to be an appraiser willing to ‘hit that bid’. The
professional societies within the appraisal industry have sought
help from federal regulators but have neither the lobbying dollars
to advocate change nor the voice to stimulate it. Over-appraisal
distorts value and undermines the integrity of the loan even
before it is originated. It also reduces the ability of servicers to
estimate default rates and losses in a declining real estate markets.

Over-appraisal creates a false market and risks increasing the
debt of both homebuyers and refinancing homeowners. This
economic risk is magnified in the event of a layoff or other
adverse economic shock."

One of the reasons low down payments like FHA are so dangerous is that the appraisal process is such an inexact science and unknowledgeable buyers can be easily put into homes that aren't really 96.5% LTV homes but considerably more underwater. The GSE's & FHA (and by extension, the taxpayer) should be much more concerned about the appraisal issue but they and the other RE related groups are fighting any meaningful appraisal reform.

There is much more in the paper and it makes me wonder just how far back things would go if the government wouldn't try and prop up the market with its massive subsidies. It is clear many of the uneconomical practices that would be removed from the market if the market was left in private hands will not be eliminated. The question becomes if these inefficiencies are enough to blow up the market or just simply create a long term drag on the USA and reduce our worldwide competitiveness. Either course isn't desirable but the process is so highly politicized and voters of all parties are clearly voting themselves entitlements and politicians are pandering to the masses that it is just a reality that will have to be lived with.

FHA gaining in latest September 2008 Ventura County LTV chart

(click to enlarge)

This is the Loan to Value chart for Ventura County September 2008. The left axis represents the purchase price of a home and the bottom axis represents the LTV of the loans on the homes at purchase. So a dot at $300,000 and 80 LTV would mean that a borrower put $60,000 dollars down on a $300,000 home and the loans on the home total $240,000. The higher the LTV the more aggressive the loan is considered to be. By click on the graphic you will notice the almost solid red line at around 97% LTV. This represents FHA singular dominance in the aggressive lending arena. The shaded blue area represents where private mortgage insurance is bring eliminated for conforming loans (Loans under $417,000). The shaded green area represents where private mortgage insurance is being eliminated for "Jumbo conforming" loans (those under the jumbo conforming limit which was $729k and is being lowered to $598k January 1st, 2009). In these two shaded areas the blue dots (conventional) should disappear by early 2009 and only red dots (FHA) should remain. The pink line represents the old jumbo conforming limit and the green line represents the new jumbo conforming limit. The loans in between these two lines will most likely not be made after January 1st. Or if they are made they will be made at much higher rates than those under the limits shown.

The WSJ had an article on the FHA tonight that ties with what the chart is telling us is happening in the marketplace (emphasis added) :

The FHA, which insures lenders against defaults on home mortgages that meet the agency's standards, saw its share of new mortgages increase to 26% in this year's third quarter, up from 3% for all of 2007, according to Inside Mortgage Finance.
Some worry that the growth has come too fast, especially as the FHA expands rapidly into the most risky markets and insures bigger loans.
...
Still, some housing experts worry that an outsized share of the FHA's new business is coming in these high-cost housing markets. "It's getting into markets that are a lot riskier than it has in the past," says Ann Schnare, a housing consultant.
...
Private mortgage insurers are more restrictive. For instance, Genworth Mortgage Insurance Corp. requires down payments of at least 10% in areas with falling home prices and 15% if the loan is larger than $417,000.
...
As the private market imposes much tougher standards, the danger is that the riskiest loans will flow to the FHA, says Joe Rogers, an executive vice president in the home mortgage business of Wells Fargo & Co.

Financing and the home loan market are a slow moving train, the fate of whether or not some of these decisions made to be aggressive in the face of a falling market won't be decided for some time now. But if the FHA is wrong it is the taxpayer that will be bailing them out. Business Week had an article on FHA and how some of the brokers were gaming the system just like during the subprime boom. If enforcement isn't stepped up to police the originators this issue could blow up even bigger than expected. Putting a large number of people who clearly have an unreasonable expectation for price appreciation for homes into instantly underwater homes during a downward economy sure doesn't seem like a good idea. Defaults on these originations should reach very high levels and I can imagine a congressional hearing sometime in the future when the taxpayers will be asked to pay for this when some FHA official will be saying, "Nobody could have possibly seen this coming".

Mortgage Application Purchase Index

This is a graph of the Mortgage Bankers Association Mortgage Application Purchase Index since August 2004. One of the things this shows is that the massive increase in mortgage applications being reported by the media isn't a function of purchases but an attempt by many to refinance and get lower rates.

There are several issues with the purchase index, it only encompasses an estimated 50% of the market because not all lenders participate. So major players can enter or exit the market and not be represented by the index. The index also doesn't dedupe applications so a person applying to multiple places will be counted several times in the index. At times of market of major market fluctuations this can cause the chart to show more activity than eventually comes through on the closed home sales numbers.

NAHB / Wells Fargo Housing Opportunity Index for Q3 2008

(click to enlarge)

I like the National Association of Home Builders / Wells Fargo Housing Opportunity Index because it hasn't changed since they instituted it except to add more cities. When affordability got ultra-low they didn't change their methodology to try to redefine affordable. Now this may seem like a small thing to most, But the C.A.R. changed their methodology when affordability got low because they (apparently) couldn't exactly go around saying houses are unaffordable. To their credit NAHB/WF didn't change and as another hit to their credibility, C.A.R. did.

Ventura's lack of long history in the index and significant addition of new housing during the boom make it hard to make a judgement as to what historical affordability is. We can see in both charts that affordability is improving but still low. As we enter the recession affordability will still improve because fewer buyers will be able to buy between still high prices, job losses and continued mortgage credit tightening. Falling prices will eventually help as will lower interest rates but this is a tough environment to push volume. If loan modifications take hold and slow down motivated inventory coming on market the best we will get is low inventory and low sales with continued falling prices.

Weekly Active/Pending counts SFV & Ventura - 12/20/08

I'm going to post the weekly inventory counts for Ventura County and the San Fernando Valley as more time goes by this data set will become more useful.

San Fernando Valley:
Single Family Homes
Active 3830
Backup 361
Pending 1265

Condo
Active 1325
Backup 98
Pending 383

Ventura County:
Single Family Homes
Active 2169
Contingent 578
Pending 627
Release from Showing 302

Condo
Active 738
Contingent 188
Pending 191
Release from Showing 63

The holiday doldrums are upon us, little new inventory and lots of homes expiring or being pulled off the market. Even in the face of very significant interest rate cuts there is still falling pendings. Expect this to continue until mid-January or early-February.

Fannie / Freddie unveil their loan modification program

One would think that the entities holding $5 trillion in mortgage debt revealing their loan modification program would be a big deal. Supposedly streamlined loan modifications will be what saves the market and the borrowers from the debt burden they got themselves into. Unfortunately the reality is that few loan modification programs strike a balance between the incentivizing the borrower to stick with the loan or convincing the lender to take the haircut. The GSE loan modification model is a horrible deal for the borrower and it is hard to see where someone will take the loan modification and have their long term situation improve in any way.

Here are the basic steps for a Fannie/Freddie loan mod. (PITIA is Principal, Interest, Taxes, Insurance and Association dues)

1. Taking any delinquent payments add it back into the loan.
2. Extend the loan term to 40 yrs, if PITIA is above 38% go to step 3
3. Reduce interest rate down to 3% in .125 increments to attain a 38% PITIA. If the final interest rate is at or above market rates then fix the interest rate on the loan for the life of the loan. Otherwise interest rate stays fixed for 5 years and then moves up 1% a year until it matches market rates at the time the loan is modified. If PITIA is above 38% go to step 4.
4. Principal forbearance. Put the amount of principal necessary to bring the loan amount down enough to get the PITIA below 38% as a balloon payment due at the end of the loan.

The 38% PITIA as a sustainable housing payment is insanely high. It isn't even total PITIA this is all about the first lien mortgage and no other mortgage debt or any other debt is taken into account. Loan modifications programs should be designed to be sustainable if they have any chance of success but they instead are designed to milk as much cash flow out of the borrowers before the inevitable default. Also the property has to be more than 90% LTV of the mortgage being modified. This program is just like Hope 4 Homeowners, blatantly structurally flawed in such a way to ensure the programs failure. The only logic I can behind unveiling such a program is show the politicians they are "doing something" even if what they are doing will have little to no effect on the marketplace. For many borrowers in bubble areas it seems like stopping payments and saving money and staying into the home until you get kicked out is the most financially sound decision they can make. I don't see the GSE loan modification program changing the calculus of that decision much at all.

CalHFA suspends some programs

The California Housing Finance Agency has stopped making some loans due to budget issues facing California. One of the ways 100% financing was still available was through programs available through CalHFA. Down Payment Assistance programs were a way of bridging the gap of the final 3.5% required of a FHA loan (seller funded versions of DPA's were banned earlier this year). Mortgage credit continues to contract and remove the marginal buyers from the marketplace.

"More are moving out of California than in" - LA Times

Just in case there are any housing bulls left I'd like to point them to the fact that for the fourth year California has experienced net out migration to other states. This doesn't mean't population has declined, due to births and international migration population has still risen. But it is clear more and more Californians are giving up on California and moving to places they can actually afford.



"The outflow -- last seen during the economic and social struggles of the 1990s -- started when it became too expensive for most people to buy homes in the state, and has kept going throughout the bust with the loss of so many jobs.The trend underscores the state's sour economy as layoffs continue, the fiscal strain on government grows and home values continue to decline.

...

"I just gave up," said Grace Bryant, a former Glendora resident who fled to Texas after 18 months without consistent employment as a residential appraiser. "California is too much of a struggle."
...

"This was the epicenter of the housing meltdown," said John Husing of Economics & Politics Inc., a regional economic research firm. "People started leaving California because of housing prices -- particularly younger couples that just couldn't afford to buy a house.""



Economist John Husing remains bullish though:

"The native Californian said the state had always priced out the working class and been an expensive place to do business, yet it continued to reinvent itself through innovation and entrepreneurship."



I think young couples and people wanting to retire on their equity will leave the state, leaving quite a gap between haves and have nots. It isn't clear how we can continue to price out the working class and retain an attractive place to live. It has been working so far and I think the credit bubble was one of the reasons it could work. But with the strains coming to local & state government the entitlement programs will be under seige and I think the working class will find more and more reason to leave.



WSJ has a graphic and article on the coming budget crisis:

San Fernando Valley November 2008 home sales report

The official November 2008 numbers are out. Homes sales (SFH) came in at 633 (my estimate was 630) which was down 15.03% MoM and up 78.31% YoY. Median price came in at $375,000 (my estimate was 385,000) which is down 8.54% MoM and down 32.74 YoY. SFH median prices are currently down $280,000 from the peak or -42.7%. October and November of last year were the weakest months of the year due to the lenders pulling away from securitizing mortgages and Countrywides famed troubles so the year over year comparisons are easy to beat. Sales are still weak and prices continue to fall.

Condo sales came in at 199 (my estimate was 202) which is down 14.95% MoM and up 41.13% YoY. Median price came in at $220,000 (my estimate was $245,000) which was down 2.22% MoM and down 41.33% YoY. Condo sales are still performing horribly despite massive declines. Considering all the condo projects in the valley this doesn't look to reverse anytime soon.

Here is the Back on Markets relative to sales, this months pendings and last months pendings. I am trying to find the best representative way of showing how pendings falling out of escrow are affecting sales.

Sales for November totaled 832, escrows opened in November totaled 951 and BOM came in at 355. Based on current pendings and BOM ratios compared to previous trends Decembers total sales (SFH + Condos) should come in around the 650 range.

As the PMI changes take affect combined with the Jumbo conforming limit dropping we will see the mid to high level market taking the brunt of declines. People wanting a loan above the Jumbo conforming limits will pay a high premium and the people wanting to pay less than 85% LTV on a Conforming Jumbo will have to go FHA which can be restrictive. From what I am seeing is an inkling of what is to come in some of the data. You see the conforming loans staying liquid and closing pretty well. Above the conforming limit there is this logjam of contingent homes waiting to close, I am assuming besides the normal bank delays for short sales and REOs that financing is an issue and people are working to get deals closed before buyers give up. This may have contributed to the decline in median due to mix shift. The higher up the price range you go the less demand is able to be effective.

Ventura County November 2008 Sales

Dataquick released figures for Ventura County today. Sales of 729 were down 9.1% MoM and up 41.3% YoY. The median prices was reported as $355,000 which is down 5.3% MoM and down 31.9% YoY. Foreclosure resales were 47.8% of sales for November. This is just more of the same deterioration with banks staying motivated during the slow months price suffers. Considering the headwinds of the market some might think this isn't that bad of a report. But in historical context this is clearly a dismal sales report.

Dataquick claims that sales were low because there were fewer business days that the recorders office was open. I think it is much more likely that sales were this weak and the effect on recording due to fewer business days wasn't that great. With the month ending on a holiday weekend that might have some minor affect but no data I see anywhere suggests that this will be a December of any strength.

Mortgage Insurers tighten underwriting again.

This James Lockhart quote made me want to review any new mortgage insurance guidelines:

“You will probably see in the next quarter the Fannie and Freddie lines going down and FHA coming up,” Lockhart said. “Fannie and Freddie are so dependent on mortgage insurers because they can only buy loans with 80 percent loan-to-value ratios and they aren’t able to do as much.”
“In some markets, the mortgage insurers have tighter standards than Fannie and Freddie,” Lockhart said. “So if someone wants more than an 80 percent loan-to-value, they have to go to FHA.”

A bit of an exaggeration but it is very true the mortgage insurers have tightened considerably in California.

The current guidelines can be summed up by the following criteria, for conforming limits 90% LTV and 720 FICO. For Conforming Jumbo 85% LTV and 720 FICO. There are minor variations on max Debt to Income (DTI) but most max out at 45%. One insurer (United Guaranty) won't insure a loan over the conforming amount in severely declining market. Which brings us to another common theme of the insurers, if they break out a state in declining severity California is considered in the worst classification.

The "Jumbo" conforming limit is dropping from $729k to $625k for Los Angeles County and down to $598k for Ventura County. In addition mortgage insurance on the mortgages between $417k and the jumbo conforming limit face either coming up with 15% down or going FHA with its expenses and restrictions (not all properties or borrowers qualify).

If you would like to take a look at the mortgage insurers guidelines they can be found here, here, here, here and here.

Weekly Active/Pending counts SFV & Ventura - 12/13/08

I'm going to post the weekly inventory counts for Ventura County and the San Fernando Valley as more time goes by this data set will become more useful.

San Fernando Valley:
Single Family Homes
Active 3885
Backup 358
Pending 1297

Condo
Active 1356
Backup 95
Pending 404

Ventura County:
Single Family Homes
Active 2245
Contingent 587
Pending 666
Release from Showing 293

Condo
Active 737
Contingent 198
Pending 200
Release from Showing 68

The holiday doldrums are upon us, little new inventory and lots of homes expiring or being pulled off the market. Even in the face of very significant interest rate cuts there is still falling pendings. Expect this to continue until mid-January or early-February.

Short Sale & Foreclosure for San Fernando Valley & Ventura County - Novemeber 2008

Here are short sales and foreclosures as a percentage of total sales for November 2008.

Here is the San Fernando Valley:


Here is Ventura County:

You can see the banks continuing to stay motivated and push inventory as much as possible and we may see distressed sales hit 2/3 of all sales in Ventura in December. An amazing statistic. Also as I have mentioned before I think distressed sales are underrepresented because some agents do not set the proper flags for foreclosure or short sale.

Anytime you hear how "great" sales are in a news article just remember that they would simply be horrible if it wasn't for the banks staying motivated. In the context of these numbers traditional metrics like months supply of homes means little. The banks are intentionally pricing low to reduce time on market. Months supply will drop as a result of this but it isn't an indication of strength. Inventory on the market should continue to drop as discretionary sellers recognize the bad market conditions and give up even though a sale now will probably net them more than a sale in the next few years.

Weekly Active/Pending counts SFV & Ventura - 12/06/08

I will be posting the short sale & REO percentages for November sales tomorrow night.

I'm going to post the weekly inventory counts for Ventura County and the San Fernando Valley as more time goes by this data set will become more useful.

San Fernando Valley:
Single Family Homes
Active 4026
Backup 349
Pending 1327

Condo
Active 1361
Backup 105
Pending 420

Ventura County:
Single Family Homes
Active 2289
Contingent 595
Pending 701
Release from Showing 292

Condo
Active 753
Contingent 196
Pending 191
Release from Showing 64

Preliminary November 2008 San Fernando Valley Home sales

Here are my estimates for November 2008 sales for the San Fernando Valley, Single Family Home sales look to come in around 630 and median price of approximately $385,000. Condo Sales are estimated around 202 and median of $245,000. Seasonality and lending guideline changes hitting the market hurt the market in November there is a possibility that the Thanksgiving holiday will cause a higher number than normal late reporters. We will know more about that in 2 weeks.

The issues that will be affecting the market for December and January outside of seasonality will be the Federal Reserve targeting longer term interest rates trying to reduce them. This has brought mortgage rates near 5% for vanilla, well qualified borrowers. Loan modification plans are starting to be rolled out en masse trying to relieve the foreclosure pressure. The headwinds to all that is continued contraction of mortgage credit and lending guidelines and of course the economy.

Weekly Active/Pending counts SFV & Ventura - 11/29/08

I'm going to post the weekly inventory counts for Ventura County and the San Fernando Valley as more time goes by this data set will become more useful.

San Fernando Valley:
SFH
Active 4153
Backup 353
Pending 1368

Condo
Active 1411
Backup 108
Pending 425

Ventura County:
SFH
Active 2380
Contingent 592
Pending 713
Release from Showing 293

Condo
Active 772
Contingent 192
Pending 196
Release from Showing 66

Private Mortgage Insurance funding falls as FHA shows strains.

Mortgage Insurance Companies of America (MICA) said in a press release that new private mortgage insurance funding in dollars dropped almost 70% last month from October 2007. October 2007 was a very slow time for sales but the mortgage insurers hadn't yet adjusted their guidelines enough to cut off the dangerous loans and are now paying the price. Defaults surged 35% year over year and the numbers last year included an insurer which is no longer in business or reporting to MICA (Triad Guaranty).

FHA has widely replaced the gap in insuring high Loan-To-Value mortgages and is seen as the most aggressive avenue left for funding. Borrowers have been pouring into this avenue for subprime mortgages and this is causing the cushion for losses to drop as defaults and the value of the mortgage book surges:

The audit, prepared by Integrated Financial Engineering Inc. of Rockville, Md., estimated the economic value of the FHA's insurance fund was $12.9 billion as of Sept. 30, down 39% from a year earlier.

The FHA insures lenders against defaults on home mortgages that meet standards set by the agency. The drop in the economic value of the fund largely reflects estimates of how falling home prices and growing losses on the sale of foreclosed homes will increase claims paid by the FHA. To calculate the economic value of the fund, the auditors make assumptions about future cash flows and adjust the fund's assets accordingly.

The estimated value of the fund as of Sept. 30 worked out to 3% of total loans insured by the FHA, down from 6.4% a year ago. Federal law requires the ratio be at least 2%. If the FHA runs short of money to pay claims, Congress would have to provide taxpayer funds to make up the difference. The share of new mortgages insured by the FHA jumped to 26% in this year's third quarter, from just 3% for the full year of 2007, according to Inside Mortgage Finance, a trade publication. Now that the subprime market has collapsed, the FHA is shouldering most of the risk on loans to people who can't afford more than a small down payment.

The taxpayer will foot the bill for this subprime lending but there is the possibility that if mortgage credit contracts too fast we could end up paying more in losses from an overshoot in prices (which many feel will happen anyways) than we would by funding the losses of the FHA.