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One Reason Obama's Refi Program Won't Work: The FHA is Insolvent

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.

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