MBA Chairman excerpts on the problems with FHA

Interview with outgoing MBA Chairman David Kittle (emphasis mine):

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.

WSJ: No Easy Exit for Government as Housing Market's Savior

From the WSJ:

His administration released a 51-page report detailing rescue programs that are slowly being scaled back. But the Treasury Department, author of the report, noted that housing is one area where it's too early to exit.

Flash of the obvious that the USG won't be backing away from housing anytime soon. But there is a difference between making sure the mortgage market doesn't freeze up and the tremendous distortion of mortgage rates now being undertaken by the Fed. While one is USG policy and the other is the "non-political" (/sarcasm) Fed they are working in concert.

More from the article:

Over the past year, the government has intervened heavily at essentially every stage of the home-buying process. In fact, more than 80% of the new residential mortgage loans made this year benefited from some form of government support, according to the trade publication Inside Mortgage Finance.

As I understand it the MBS issuance part of the market is something like 97% government supported (according to a recently released GAO report). So you either fit the GSE/FHA guidelines or find a local bank whose guidelines that you can fit and they portfolio the loan. But the support is at every level, the Fed is buying $1.25 Trillion in MBS debt and $200 billion in short term GSE debt. This is causing rates to be ultra low. This confluence of Fed and Treasury policy along with political policy has completely been directed in keeping housing afloat. One certainly wishes they spent a tenth of the energy before the boom making sure this didn't happen instead of wasting all this energy once it happened trying to keep the dreaded DEFLATION from happening.

In regards to the expended "jumbo conforming" loan limits is will be of no surprise that no administration would ever allow these "temporary" loan limits to ever revert back to their previous levels. The political cover to raise the limits, and thus the risk to the GSE was that it was temporary. Anyone with any sort of sophistication at all knew the lie when it was being told. The loan limits have never gone down and the government has never done anything to support the housing market less. As the article states:

The government temporarily raised the size of the loans Fannie and Freddie can guarantee in February 2008 and is unlikely to ever return to previous levels. The higher levels have been extended once, and the mortgage industry is lobbying to keep them high.

And on the Feds role:

When the Fed buys up to $30 billion in mortgage securities every week, regardless of price, "it makes it very difficult for the market to find its own equilibrium," says Ajay Rajadhyaksha, head of U.S. fixed income research at Barclays. He said investors are trading in Treasury securities instead, pushing rates lower in that market, too.

The Fed is likely to decide to carry on buying until it reaches the $1.25 trillion target it set in March, and then taper off gradually. Some Fed officials will likely argue for stopping sooner, even as soon as next week's regular policy meeting.

If the Fed stops sooner than expected, it could jolt the mortgage market and short-circuit a housing recovery. Barclays's Mr. Rajadhyaksha estimates that even if the Fed carries on as planned, mortgage rates will rise by half to three-quarters of a percentage point, simply because the Fed will cease to be as a big a presence in the
market.

Note they suggest that it is possible that the Fed will finish out the $1.25 trillion purchases this year then come up with a new level of printing money and "slowly" back away from the market. While MBS purchases may eventually wind down in the next year (I'm being optimistic) the short term GSE debt purchases I am sure will continue to keep them afloat.

It all boils down to continued long term heavy USG and Fed involvement. Like the traders in the MBS market who have backed away from purchasing MBS because of the massive Fed distortion, I wonder how a rational home buyer can enter the market now. They are either ignorant of the risks, don't care about the risks or are rich enough where it doesn't matter. People have to understand that the market "bottom" is predicated on 5% rates and supply being choked off while non-paying borrowers get a pass. You would have to be very confident of those two issues continuing for a significant time horizon or don't care you are throwing money away buying a home because you won't be able to sell it for what you owe later.

Also the hyperbole needs to end, literally everyone has assumed that if any of these programs get scaled backed or stopped the housing market ends. No, it doesn't end, prices just go down. Demand is there, if anything the housing boom has proven is that people want to buy homes and will go to great lengths to do so. Rates need to rise to a level commiserate with the risk being taken, then the private market will return to lending. Instead we have massive subsidies to the system. Prices need to fall to a level where local incomes support them at normal interest rates. We have some really hard choices to be made and time has passed and there is no evidence that they will be made. We just keep kicking the can down the road.

End Game?

Much of this post is speculation on future events by me. Do not take my opinion/rant as facts. I only offer up a possible outcome over the near future for the housing market. As I have watched the market I have seen little more than the emergency brake have been hit by the Fed with little resolution to the fundamental problems facing the market of overleveraged borrowers getting in way over their heads. I present this as possible outcome:

I found this summary of a report Amherest Securities Group on Housing Wire
to be interesting and could point to a final plan developing to remove the mortgages off the banks books and onto the backs of the taxpayers. Basically the report points out that short sales result in higher recovery rates than foreclosures. This makes sense for two reasons. One, the property is still owner occupied or just recently vacated meaning the home would have less deferred maintenance than your typical foreclosure. And two in a declining market the sooner you get out the more your recover. This shows why the industry needs to come up with a uniform way of first and junior liens cooperating to divvy up the proceeds of a short sale instead of the senior liens telling the junior liens "this is what we are offering" and the junior liens using the "hostage value" of their lien to try and get more.

The other part of this report points out that a new Hope for Homeowners (H4H) is in the works. With this option Amherst believes the loss would be the same as the short sale, the owner still keeps the home and the bank no longer has a bad loan on its books. Any default from that point forward comes out of the FHA insurance fund and, if that fails, the taxpayers. I believe this to be the end game for the administration. The Fed can tremendously influence rates, however temporarily, they can bring down rates to even lower levels so the qualification for H4H is easier and the banks can put as many loans in H4H in as little time as possible. While there may be a hit to capital to the banks they magically turn a non-performing loan into a performing loan which carries zero risk and they wouldn't have to withhold any capital or increase loan loss reserves against it.

Moral Hazard? Yes, not an issue to the Fed. Price Discovery? No, exactly what the banks and government want. Overleveraged borrowers get to keep "their" home? Yes. Saving the too big to fail banks? Yes, it may require an additional capital injection depending on the initial H4H losses. Keeping the housing market stagnated and inflated? Yes.

I think it is as good as the administration can expect given their goals of keeping the housing market inflated and as many borrowers in homes as possible. Needless to say I see a taxpayer funded bailout for FHA coming a few years down the road but they get to kick the can and politicians will always do that over making the tough decisions.

The only losers are the fiscally responsible and those who pay the majority of taxes. Truely this is an ownership society and homeowners are a protected class of people. I am sure we will hear more about a new much more lenient H4H probably by early next year.

EDIT:
From the April 28, 2009 MHA press release:

"Support for Legislation to Strengthen Hope for Homeowners: In order to ensure that many more borrowers are able to participate in Hope for Homeowners, we are working to improve the program and actively pursuing legislation so that the FHA may reduce fees paid by borrowers, increase flexibility for lenders to refinance troubled loans, permit borrowers with higher debt loads to qualify, and make further improvements to strengthen Hope for Homeowners so that it can function effectively as an integral part of the Making Home Affordable Program. "


"Treasury Purchase of Special Ginnie Mae Pools to Provide Liquidity for Hope for Homeowners Loans: Under HERA authority, Treasury or the GSEs would purchase special Hope for Homeowners Ginnie Mae IIs wrapped by the GSEs. These purchases will increase secondary market liquidity for new Hope for Homeowners loans, supporting additional assistance to homeowners. "