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Easy-money mortgages still provided, by the feds

- The Washington Times - Monday, October 19, 2009

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 - unsustainable 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 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 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.

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 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 criticism 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."