LEW: Another good segue: You mentioned the FHA. Is the FHA a looming problem out there?
DAVID: It is a huge problem, probably potentially bigger than the issues we have right now. The brokers ran and got approved FHA when they probably shouldn't have. And they are taking the loans that they used to do subprime and taking them to the FHA. And it is a huge problem. The FHA insurance fund is under duress.
LEW: If the problem is not address, when are we going to see it explode, and what should we do to prevent that from occurring.
DAVID: The horse is already out of the barn. But that doesn't mean you can't go out and shoot the horse. To answer your question specifically, we need higher net worth requirements, higher level of entry into the business, and loan officer registration. The registration system is now in place. That's for everybody, and everybody agrees with that - bank, lender, broker.
But we need to hold to our underwriting standards. Right now, we are approving some people who shouldn't be approved. Their credit scores are too low. FHA still has the flexibility. Lew, when you are an underwriter - and I'm a delegated underwriter, by the way - you can sit there and still make a business decision on an FHA loan that you can't on a conventional loan. When it goes through Loan Prospector or Desktop Originator, Fannie and Freddie, and it comes back as a refer, that loan's dead. But if you input an FHA loan through LP and it comes back refer, you can go outside the guidelines. You have to take responsibility for the loan, but you can override that refer and approve that loan.
We need to get back to underwriting the way we used to do it. Say there's a bankruptcy because the borrower didn't pay his bills on time and squandered his money. Or I had a bankruptcy because I had a health issue, my wife died and I had paid my bills on time up until that point. You have to be able to look and make a judgment on the explanation given.
LEW: So are you saying FHA's underwriting rules are much too lenient right now?
DAVID: I'm saying right now that FHA underwriting rules are good, but they need to be followed stringently. There is flexibility in those rules that you don't have conventionally, so you have to be careful. That's one of the things that has always made FHA a great program, but right now, it is being abused. And next year, I fear we are going to pay for it.
FHA has the ability to go outside the guidelines and still approve the loan. But there isn't a downside for the brokers pushing people into bad loans outside the guidelines. The default rates have to get very high before FHA even notices and even higher before they do anything about it. Brokers are very good at finding the weak point of the system and exploiting it to their maximum. They are smart and find ways to get loans done... even if it wasn't one that is supposed to get done. These holes in the system will cost billions of dollars.. the open question now is how many billions and if/when the taxpayer has to pay them.
Banks & Brokers should have part of their commissions withheld by FHA for 24 months and that money is in the first loss spot if the loans goes into default. That way it won't be just the commission for one loan on the hook and the pain felt will be significant for the shop. The better loans they make the more money they make.
Much more in the interview on loan mods and the future of Fannie/Freddie... it's a good read.
Note: There isn't much talk about fixing the problems with FHA.. only expanding it so it will do more loans. Imagine New Century Financial / OwnIt / MLN type thinking but backed by Congress.