In his State of the Union address last month, President Barack Obama outlined a plan to let homeowners, especially those underwater, refinance older mortgages to take advantage of today's low rates.
While serious political impediments stand in the way of the Obama refi plan, one reason it won't work is that it relies 100% on the Federal Housing Administration (FHA).
The problem is that the FHA is technically insolvent.
That "minor" issue could make the president's plan a non-starter.
The FHA doesn't originate mortgages. It is a government agency that insures 100% of the principal and interest on residential mortgages to the benefit of mortgage lenders.
The president's plan is to have the FHA insure all "eligible" borrowers' loans so lenders have a guarantee that refinanced mortgages will be paid back.
That incentivizes lenders to make loans they otherwise wouldn't make.
Why the FHA is Insolvent
Borrowers pay an upfront mortgage insurance premium (MIP) of 1% and modest monthly fees into the FHA's insurance fund. That's the FHA's only source of income and capital.
The fund has to maintain certain reserves and a cushion against the total obligations it has amassed based on the insurance it has in force, which currently exceeds $1 trillion.
The FHA is technically insolvent because it is already below the minimum 2% "economic value," or capital ratio it's required to maintain by law.
In fact, according to an American Enterprise Institute "Outlook" report, the FHA has only $1.2 billion in "economic value" supporting over $1 trillion on loan guarantees.
In other words the FHA's leverage ratio is close to 1,000 to 1 and its capital ratio is 0.12% — nowhere close to 2%.
For some perspective on how far the FHA has slid in reverse, in 2006 its capital ratio was 7.38%.
Things aren't getting any better for the FHA either, they're getting worse.
Capital adequacy at the FHA is based on "projections" that are a moving target. The agency calculates its financial position on assumptions about current and projected delinquency and default rates, future premium payments and housing price trends.
Delinquency rates are currently rising faster than projected.
As of December 30, 2011, 12.1% of FHA-insured loans were 60 days or more past due, which is up from 10.55% on June 30, 2011.
And the American Enterprise Institute's Ed Pinto has been pointing to the alarming fact that 18% of all FHA-insured loans are now at least 30 days past due.
Another problem the FHA has is that its capital isn't just based on tangible assets.
It calculates future premium payments as part of its economic value. The American Enterprise's Outlook report equates this ledger domain to what Enron did when it was booking unearned income based on projections it fabricated into its earnings.
And, as if the FHA's current position isn't bad enough, its future financial health is predicated on its projections that U.S. housing prices will grow at a 4% annual rate well into the future.
Obama's Refi Plan: Massive New Guarantees
The FHA has a credit line with the Treasury Department and argues that it won't be a burden on taxpayers because future premium payments and an improving housing market ensure its solvency. And yet there's no accounting for the potentially massive increase in loan guarantees it would have to make under the president's refinancing program.
These refinanced loans will be made to borrowers who, while possibly lowering their monthly payments, will still owe more than their homes are worth.
Congress has to approve the president's refinancing plan along with the $61 billion "bank tax" he proposed to help pay for the plan and other homeowner assistance programs.
In a politically charged election year, it might be impossible to get backing for the president's refinancing program if taxpayers are made aware the program relies on an already-insolvent FHA further leveraging itself on an uncertain economic future.
Not only have Republicans denounced the president's proposed $61 billion "bank tax" as dead-on-arrival if it ever comes their way in either the House or the Senate (a proposal to raise half that amount in last year's budget failed), but general concerns about moral hazard and strategic defaults by borrowers whose loans are FHA guaranteed are sure to surface.
When borrowers with credit scores as low as 580 – who only have to put down 3.5% on an FHA-insured mortgage and can borrow up to $729,500 – end up piling on the government gravy train, at least we'll know how it might turn out.
Will we ever learn?
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