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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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About the Author
Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.
He helped develop what has become known as the Volatility Index (VIX) - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk, and established that company's "listed" and OTC trading desks.
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THAT'S CRIMINAL.
Very much appreciate your articles.
I gotta ask…are you using a voice recognition system to dictate your commentaries? Wouldn't surprise me, as they're beautifully conversational.
I ask, because the word legerdemain came out "ledger domain." Kind of funny as there was definitely some ledgerdemain in the ledger domain over at the FHA.
It's crazy. I like President Obama over the radicals on the Right, but it always bothers me how unimaginative he can be sometimes. Trying to inflate housing prices artificially is absurd and at best would lead to another bubble. Not only that, it leads to more over-building, urban sprawl, and destruction of the environment just so that they can build more houses that will end up in foreclosure. There is only one logical intervention to stabilize housing prices, and that's to allow more immigrants in so they can live in all those houses that were built. Once there are enough people to live in the houses already built, then housing prices will stabilize.
You never mentioned the 26 billion dollar settlement with the big banks of which $1billion will be going to the FHA in your article. Why is that?
Now don't get me wrong, I am not a fan of the refinance plan either. But the reason I am not a fan of it is because it doesn't really help fix the problems. Letting only those people who are current on their loans that are upside down does not stop the majority of the loans that are headed for foreclosure. Those people who can afford their loans are not the ones who will be the ones who will be adding to the glut of foreclosures. It is the ones who can not afford their loans that are going to be the majority of the loans that are going to go bad and perpetuate the housing woes. This refi program is designed to help those responsible people who have been making their payments who find themselves upside down on their homes anyway refinance into better loans. From that stand point it almost seems like something the Republicans would do not the Democrats but the bottom line is that no matter how much those people may deserve the break more than the people who got into loans they could not afford helping those people is not what is going to end this crisis. The truth of the matter is that the banks and the government have done nothing but perpetuate this crisis from the beginning. The banks made business decisions to not work with people who were in trouble. They turned down loan mods, were in no hurry to approve short sales and ended up taking back millions of homes in foreclosure which they proceeded to sell for much less than what they may have been able to do a loan modification on. (I am talking a reasonable modification not the crap that they call a loan mod that just puts the person back in foreclosure 6 months later) These sales influenced market value and have driven down property values for everyone. Where as a legitimate loan modification would have never impacted the property values at all. I hear people complain about this crisis being all about those people who had no business buying a home to begin with getting into homes they could not afford but what I have seen is: Government bailouts of "too big to fail" financial insitutions who were then allowed to become even bigger instead of being broken up so they no longer posed a national security risk. Those top down bailouts never made it past wallstreet down to mainstreet. I have seen a settlement that was supposed to be about robosigning fraud that the banks perpetuated against people who subsequently lost their homes and yet those that have lost their homes are the ones to reap the smallest compensation from the settlement. I see a refi plan that is designed to help not those who are in need of it to keep their homes but one designed to help more affluent home owners so they are no longer upside down on thier homes. It seems to me that the poorest have been forgotten about while the wealthiest have been protected. No doubt that our taxes are going to welfare but the welfare of who? That is the question!
I've been in the mortgage industry for over 25 years. Over the past 4 years since the housing
mess – FHA has become the new subprime loan. Your article is 100% accurate and we don't
ever learn. FHA also allows the highest debt to income ratios of any mortgage out there. They
will allow your housing payment to be as high as 55% of your GROSS income. So people take
home 70% of that and have 55% going to their house. That leaves 15% of the gross family
income to cover food, utilities, insurance of any kind, gas for your cars. They are doomed to fail
from the start. And its the governement insured program. Rediculous.
I have to ask since the title on my dashboard is HERE'S WHAT WE SEE FOR SILVER how did I end up looking at FHA?
I was suspicious of any democratic play on housing. Now this article shows why. I intend on sharing. Wish I could post on Facebook.
I have the same ?? Norman
The question at the end of the article: Will we ever learn?
A. No!
So long as the Socialist is in the White House promising federal goodies, and "spreading the wealth," there is no hope of learning from past mistakes. But that's what Obama wants. He wants America on its knees so we are no longer a capitalist economic and military power. He wants us to be like Europe, giving a majority fed stuff so they continue to vote his way. The USA is almost at the 50% level of people getting federal benefts and they are the ones who will turn our country into a Socialist regime. This can go on for just so long. Greece, Italy, and Spain are just a few examples of what is coming if we don't bouce BO out of the White House. Gos PLEASE Bless America next November!
The Private Briefing Dashboard says "Here's What We See For Silver" but I cannot even find the word "silver" in this article. Who is writing those headlines?
I need more SILVER reports 75% of my money is in Silver.