Feds back ‘new sub-prime’ easy mortgages

The Washington Times Weekly - - National - BY PA­TRICE HILL

So you thought easy-money mortgages with lit­tle or no down pay­ment for peo­ple with bad credit was a thing of the past? Think again.

You can get just such a loan to­day — and it’s guar­an­teed by the fed­eral gov­ern­ment.

Loans in­sured by the Fed­eral Hous­ing Ad­min­is­tra­tion (FHA) have be­come “the new sub­prime,” and th­ese loans are ex­pos­ing tax­pay­ers to the same kinds of soar­ing de­fault rates and losses that brought down Fan­nie Mae and Fred­die Mac as well as de­stroyed many banks and the pri­vate mar­ket for mort­gage loans.

While pri­vate lenders learned a les­son from the mort­gage cri­sis and are shy­ing away from easy-money loans, the FHA has stepped into the breach. The agency has pro­vided back­ing for 37 per­cent of all mortgages used to buy homes this year.

Af­ter the col­lapse of much of the pri­vate mort­gage mar­ket last year, Congress and the Ge­orge W. Bush ad­min­is­tra­tion greatly ex­panded the FHA’s orig­i­nal De­pres­sion-era pro­gram aimed at as­sist­ing sales of mod­estly priced homes by more than dou­bling the ceil­ing on loans that the agency can in­sure to $625,500 while main­tain­ing its loose lend­ing terms — en­sur­ing that nearly any home sale could be cov­ered by the agency.

The FHA’s pre­dom­i­nance was en­hanced fur­ther this year when Congress lifted the ceil­ing to more than $729,000 for ma­jor ur­ban ar­eas and passed an $8,000 tax credit for first-time home­buy­ers that can be ac­cel­er­ated for bor­row­ers to use as a down pay­ment on FHA loans and avoid any cash com­mit­ment to their home pur­chases.

While th­ese changes were in­tended to be tem­po­rary and ex­pire by the end of the year, given the fragility of the hous­ing and mort­gage mar­kets, Congress is con­sid­ered likely to ex­tend them this fall.

The sig­nif­i­cant ex­pan­sion and lib­er­al­iza­tion of FHA’s loan pro­grams is en­abling Amer­i­cans to go back to many of the same bad credit prac­tices that an­a­lysts say were at the root of the hous­ing cri­sis, likely feed­ing fur­ther waves of de­fault and fore­clo­sure. But this time it is the tax­payer — not the banks — who could end up hold­ing the bag.

Whit­ney Til­son, man­ager of in­vest­ment firm T2 Part­ners LLC and au­thor of “More Mort­gage Melt­down: 6 Ways to Profit in Th­ese Bad Times,” called “cat­a­clysmic” the surg­ing de­fault rates of more than 30 per­cent on loans in­sured since 2006 by the FHA. That is not far be­low the 40 per­cent rate of de­fault and fore­clo­sure on the no­to­ri­ous sub­prime loans that ig­nited the credit cri­sis.

“The FHA’s port­fo­lio is ex­plod­ing and the tax­payer is now on the hook for 100 per­cent of the losses,” he said.

“I find it hard to dis­tin­guish be­tween the ac­tions of FHA and the self-de­nom­i­nated sub­prime lenders,” said Ed­ward Pinto, a for­mer chief credit of­fi­cer at Fan­nie Mae who re­cently tes­ti­fied be­fore a House panel on FHA’s grow­ing de­fault prob­lems. “The re­sults are the same — un­sus­tain- down pay­ments have high rates of de­fault be­cause the bor­row­ers have lit­tle fi­nan­cial stake in los­ing their homes to fore­clo­sure.

The agency re­quires a min­i­mal 3.5 per­cent down pay­ment — far be­low the 20 per­cent now re­quired by pri­vate lenders. That’s very lit­tle “skin in the game,” es­pe­cially in to­day’s mar­ket where the buyer’s eq­uity can be quickly wiped out, Mr. Pinto said. Home prices have fallen an av­er­age of 30 per­cent na­tion­wide.

Many bor­row­ers have been able to avoid even that min­i­mal level of per­sonal in­vest­ment in their homes. The gov­ern­ment is

Even though the num­ber of de­faults is es­ca­lat­ing, FHA Com­mis­sioner David Stevens in­sists that the $30 bil­lion of in­sur­ance re­serves will cover any losses and has re­peat­edly de­nied that the agency is headed to­ward a tax­payer bailout. The re­serves are re­plen­ished by bor­row­ers, who pay the agency yearly pre­mi­ums of 0.5 per­cent of the loan and an up­front 1.5 per­cent pay­ment when their loans close.

But an­a­lysts say his op­ti­mistic as­sess­ment is based on the shaky as­sump­tion that the nascent re­cov­ery in the hous­ing mar­ket will quickly put an end to fall­ing house prices and bur­geon­ing de­fault and fore­clo­sure rates. Many pri­vate economists pre­dict that the rates of de­fault will con­tinue to rise even af­ter hous­ing sales re­cover. They also say home prices may con­tinue to fall for a while longer, leav­ing in­creas­ing num­bers of home­own­ers un­der­wa­ter on their loans and more prone to de­fault.

In an­other de­fense of the agency, Mr. Stevens points out that the av­er­age credit scores of FHA bor­row­ers has risen in the past year as the dis­ap­pear­ance of pri­vate home loans sent buy­ers flock­ing to the pro­gram. But the deep re­ces­sion also is caus­ing in­creas­ing de­faults among peo­ple with bet­ter credit, who cite the loss of in­come be­cause of lay­offs or re­duced work hours as their prin­ci­pal rea­son for not be­ing able to make their mort­gage pay­ments.

The FHA has a pro­gram that will help peo­ple who missed two or three pay­ments un­der such

The sig­nif­i­cant ex­pan­sion and lib­er­al­iza­tion of FHA’s loan pro­grams is en­abling Amer­i­cans to go back to many of the same bad credit prac­tices that an­a­lysts say were at the root of the hous­ing cri­sis, likely feed­ing fur­ther waves of de­fault and fore­clo­sure. But this time it is the tax­payer — not the banks — who could end up hold­ing the bag.

able loans that pro­long and per­pet­u­ate our night­mare of fore­clo­sures.”

Mr. Pinto es­ti­mates that 20 per­cent of the FHA’s en­tire port­fo­lio of $725 bil­lion mortgages will end up in fore­clo­sure — a rate re­cently borne out by es­ti­mates FHA pro­vided to Congress. He pre­dicts that the agency will re­quire a tax­payer bailout within two to three years.

One rea­son de­faults are soar­ing is that the agency is at­tract­ing nearly all of the busi­ness of home­buy­ers who haven’t saved enough to make down pay­ments, he said. Loans with lit­tle or no en­abling th­ese buy­ers to put up no cash at all by al­low­ing them to get ad­vanced pay­ments of the $8,000 home­buy­ers tax credit through ar­range­ments with non­profit hous­ing groups and state hous­ing agen­cies. The tax credit can be used the same way to pay clos­ing costs.

Be­yond the loos­ened stan­dards on down pay­ments, the FHA re­mains will­ing to make loans to peo­ple with low credit rat­ings, even those with his­to­ries of de­fault, fore­clo­sure or bank­ruptcy. Those with his­to­ries of de­fault are far more likely to de­fault again. duress by us­ing the in­sur­ance fund to make those pay­ments for them and then re­coup­ing the money when the prop­erty is sold — a pro­vi­sion that has been used in about 400,000 cases so far and could help to bring down the fore­clo­sure rates on loans that go into de­fault as a re­sult of the re­ces­sion.

The agency re­cently an­nounced steps to tighten its stan­dards for lenders to counter con­cerns about ris­ing de­faults as well as cr iti­cism from the agency’s in­spec­tor gen­eral that its pro­gram is rid­dled with fraud and cor­rup­tion by lenders. The agency pro­posed re­quir­ing lenders, many of whom were sub­prime dealers, to as­sume li­a­bil­ity for the loans they make and have a net worth of at least $1.25 mil­lion.

The agency also is con­sid­er­ing tight­en­ing stan­dards for bor­row­ers who pose mul­ti­ple risks, such as those with his­to­ries of de­fault. But while the agency has moved quickly to crack down on lender abuses that likely con­trib­uted to high de­fault rates, Adam Sharp, a fi­nan­cial ad­viser and blog­ger for Bear­ishNews.com, said it is per­plex­ing that the FHA has not moved to tighten bor­row­ing stan­dards that have emerged as the low­est in the post-cri­sis mort­gage mar­ket.

“I sup­pose re­spon­si­ble lend­ing would spoil the hous­ing re­cov­ery,” he said. “The FHA has ef­fec­tively re­placed sub­prime lenders who went bust. They’re un­der pres­sure to prop up hous­ing prices, and are in­sur­ing heaps of risky loans in an ef­fort to do so.”

The FHA’s back­ers in Congress, led by House Fi­nan­cial Ser­vices Com­mit­tee Chair­man Bar­ney Frank, Mas­sachusetts Demo­crat, main­tain that high de­fault rates are the price of Congress’ de­ci­sion to use the FHA to pre­vent a com­plete col­lapse of the hous­ing and mort­gage mar­kets in a time of ex­treme dis­tress.

“By keep­ing af­ford­able loans flow­ing, par­tic­u­larly to the grow­ing ranks of first-time home­buy­ers, the FHA has been crit­i­cal to our na­tion’s eco­nomic and hous­ing mar­ket re­cov­ery,” said U.S. Depart­ment of Hous­ing and Ur­ban De­vel­op­ment Sec­re­tary Shaun Dono­van. The FHA is part of HUD.

But even some lib­eral hous­ing ad­vo­cates say the FHA’s spec­tac­u­lar ex­pan­sion could be wor­ri­some.

The agency’s low down­pay­ment re­quire­ment “may be work­able un­der some cir­cum­stances, but this prac­tice is likely to run into prob­lems in the con­text of de­clin­ing house prices and the most se­vere down­turn since the Great De­pres­sion,” said Dean Baker, co-di­rec­tor of the Cen­ter for Eco­nomic and Pol­icy Re­search.

“Fur­ther­more, given the huge ramp up in its lend­ing in a very short pe­riod of time, it seems un­likely that the FHA has been able to ad­e­quately scru­ti­nize the loans that it is buy­ing.”

While any bailout of FHA likely would be small in com­par­i­son with the gi­gan­tic sums spent bail­ing out Fan­nie Mae and Fred­die Mac, Mr. Baker said, “the crip­pling of the FHA as a lender would be an­other blow to the hous­ing mar­ket” and would be “a se­ri­ous po­lit­i­cal blow to ef­forts to en­sure ac­cess to mortgages for moderate-in­come fam­i­lies.”

BLOOMBERG NEWS PHO­TO­GRAPHS

Rep. Bar­ney Frank, Mas­sachusetts Demo­crat and chair­man of the House Fi­nan­cial Ser­vices Com­mit­tee, is one of the Fed­eral Hous­ing Ad­min­is­tra­tion’s back­ers in Congress.

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