Sunday, November 22, 2009

Are You Ready for Real Estate Crash II?

The San Francisco Chronicle's Kenneth Harney is speculating on what the Federal Housing Authority may have to do to shore up its balance sheet. A few things should be kept in mind about such a move:

1. The FHA has been a main spigot through which the government has been propping up the real estate market (See: Real Time Madness: Watching the FHA Prop Up the Housing Market)

2. The FHA is in real bad shape. John Carney points out:

The FHA has expanded from guaranteeing just 2% of mortgages to over 20% in just a couple of years, dramatically raising its exposure to the still declining US housing market.

The FHA still backs toxic, almost-no-money down mortgages. It will currently guarantee mortgages with as low as 3.5% downpayments.

The FHA's mission is political: it is still trying to "expand home ownership."

The number of mortgage companies whose loans are backed from the FHA has grown from around 1,000 to over 3,300 but the FHA hasn't grown its ability to analyze these companies.

A recent audit of FHA applications found only 5% included all the necessary documents.

The leadership of the FHA is completely oblivious to its coming ruin.

The FHA is in even worse shape than Fannie Mae and Freddie Mac

3. It should be remembered that the first real estate crash started when the Federal Home Loan Mortgage Corporation (Freddie Mac) after it announced in February 2007 that it would no longer buy the most risky subprime mortgages and mortgage-related securities. It just takes a little less buying at the margin to start things tumbling. It should also be kept in mind that Bernanke is not, I repeat, not expanding the money supply at the present time.

So what's up with the FHA when it is now guaranteeing over 20% of home mortgages with limited down payments? It is in serious trouble and will have pull tighten its credit standards somehow ala Freddie Mac in 2007. It will also try to generate additional revenue by, say, increasing insurance premiums.

What are likely possible ways in which FHA will try to do these things to shore up its balance sheet. Here's Harney's take:

1. Higher down payments. FHA's current minimum cash down payment is 3.5 percent. On a $200,000 house, a buyer can bring just $7,000 to the table, aside from closing costs. A purchase of a $500,000 house in a high-cost area requires only $17,500 in cash

2. Higher mortgage insurance premiums. Currently, FHA charges an "up-front" mortgage insurance premium of 1.75 percent of the loan amount. Most borrowers roll that into their loan and finance it. FHA also charges an annual premium, paid in monthly installments, of either 0.5 percent or 0.55 percent, depending on the down payment. To rebuild reserves, FHA could tweak one or both premiums to yield higher revenues. It could, for example, raise the up-front premium to 2 percent or as high as the current statutory maximum of 2.25 percent. It could also raise the annual fee, but the total premium could not exceed 3 percent under current congressional limits

3. Cutting home-seller "concessions" to borrowers' loan costs. One of the big attractions of FHA financing has been the agency's liberal allowance for seller contributions to borrowers to offset settlement and loan-related fees. The current FHA limit is 6 percent of the house price, which critics believe to be excessive. They say the policy effectively allows financially marginal borrowers to buy houses they shouldn't, thereby raising FHA's exposure to losses. Pinto calls the 6 percent allowance "insane on a loan with a 3.5 percent down payment." He wants Congress to order FHA to reduce maximum concessions to 2 percent.

4.Toughening credit standards. In the mortgage market, FHA is by far the most lenient and flexible player when it comes to evaluating applicants' creditworthiness. It does not have a minimum credit score, though it permits lenders to impose their own FICO score minimums. FHA also traditionally has been far more tolerant of credit history peccadilloes than Fannie Mae or Freddie Mac. When there are extenuating circumstances associated with credit problems - medical, marital or employment - FHA seeks to give applicants the benefit of the doubt.
What's all this mean? Harney puts it this way:
...wildly popular FHA-insured mortgages could be on the verge of becoming more expensive and tougher to obtain.
Are you ready for real estate crash II?

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