FHA Loans – Default Rate 8.24%

A key measure of the U.S. Federal Housing Administration’s cash reserves has dropped sharply to well below the congressionally mandated level, according to an actuarial study of the agency’s finances released Thursday.

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If the FHA’s reserves vanished, the agency would need an appropriation from Congress for the first time in its 75-year history. The agency would still honor claims against its fund, Mr. Donovan said.

Source: Wall Street Journal

*** TIP: Google has a deal with the Wall Street Journal and Barrons. You can read all content through Google so long as you access WSJ and Barrons from Google. ***

Defaults on FHA loans have been rising. A year ago, the default rate was very high and at 6.1%. The default rate is now at a staggering 8.24%. 2-3% would be high. 8.24% is simply ridiculous and means the FHA is insolvent.

Rep. Scott Garrett (R., N.J.) is pushing legislation that would lift FHA’s down payment requirement to 5% from 3.5%. On Thursday, he said the actuarial study "calls into question the fiscal soundness of the agency."

I don’t blame Rep. Garrett. He is not a miracle worker and I understand you have to take baby steps. But how crazy is it that a homebuyer only has to put 3.5% down? Talk about having no skin in the game. So now they are looking to move it to 5%. That doesn’t help change the incentives. It looks like just another stop gap measure. How about 20 or 30%?

It is unbelievable that after a total collapse of our financial system that there are still loan products offering people upside benefits and virtually no downside risk.

There is downside risk, but Congress in exchange for votes shifts the risk to the US Treasury. The US Treasury through taxation and inflation then pick the pockets of taxpaying citizens to foot the bill.

Denninger calls it the “Wimpy Syndrome.”  Left to their own devices, politicians, when confronted by a desire to spend money they don’t have, will always resort to eating the hamburger today and trying to pay next Tuesday.

What do I mean when I say people get all the upside benefits without taking on risk? Let’s use Denise Tajada as a case study. She is a smart young woman taking advantage of the FHA’s “heads you win tails the taxpaying citizen loses” loan program.

Without question, Tejada’s loan is toxic–to her and to the taxpayers who are backing the loan. Her house cost $155,000. Tejada’s loan was apparently made on a micro-down payment of just 3.5%, the minimum down payment to qualify for an FHA loan. On top of this, however, she got an additional government backed loan to make improvements. Her total loans amount to $183,0000. In short, she was immediately underwater on her new house.

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The monthly payments on her debt amount to $1328. Her income is $2470, leaving her with just $285 a week to live on. She’s paying 54% of her income to make the mortgage payments. She earns that income by holding down one full time and two part time jobs.

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Tejada sees her house as an investment rather than a home. And she is planning on buying more homes, despite the fact that her income is already strained by her debt. T

Source: Businessinsider.com

By the time Tejada receives her homebuyer tax credit she’ll actually walk away with cash from the house! Talk about creating bad incentives. Tajada’s worst case scenario is bad credit. Her best case scenario is that she gets free leverage to amass a small fortune.

This is the average person’s chance to take a risk and keep the gains using other people’s money. The only other group of people that get to do this are Wall Street bankers working at Citigroup, AIG, Goldman Sachs, et al.

But my point is that the average responsible citizen looks at defaulting homeowners as “dummies that bought more than they could afford.” Sure, there is a group of people that deserves this label. However, in many cases, it was  and is strategic behavior to take on a bet where you get to keep the upside rewards and shift the downside risk to others. So these people were not dumb. They were getting their chance to invest like Goldman Sachs.

Unfortunately, these perverse incentives still exist. If people had to put 20-30% into a house, if it lost value, their equity would be eaten up before the lender took a hit. With a 3.5% or 5% loan, there is no cushion and when the house goes down in value the FHA is immediately on the hook. The FHA doesn’t have any money so this translates to more bailouts from Congress.

There would be short term pain if 20-30% down was required and it would certainly reduce demand for housing. But, housing would also become more affordable. It is true that current homeowners would take an immediate hit, but homeowners are taking a hit anyway. It just feels better when your money is being taken away by weakening the Dollar instead of seeing your house decline in value.

It is just a shame that even after our financial system has failed, a root cause of the problem still exists. I suppose this will continue because it is a safe bet that Wimpy Syndrome is not going away anytime soon.