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Uncle Sam Guaranteeing Sub-Prime Loans

Posted by Larry Doyle on May 4, 2009 7:51 PM |

Is Uncle Sam creating another housing fiasco or merely forestalling some pain embedded in the current mess? Hat tip to bonddadddy for bringing my attention to the WSJ editorial today, The Next Housing Bust, which deserves further analysis and promotion.

This WSJ editorial focuses on the Federal Housing Administration (FHA) which insures mortgages via a 100% taxpayer guarantee. In the early part of the decade, the  FHA lost a significant percentage of its market share as borrowers who qualified for these mortgages shifted to “teaser” loans offered by sub-prime mortgage lenders. We all know how that ended.

FHA and VA (Veterans Administration) loans have traditionally been securitized by GNMA (Government National Mortgage Association) and were restricted to a maximum loan size of $362,500. Traditionally, these loans have experienced very low levels of defaults because many of the loans were of much smaller size. Oh, how times are changing!

The Mortgage Bankers Association data indicates that now more than one in eight FHA insured loans is delinquent, nearly triple the rate on conventional non-subprime loans. Aside from loans in default, the delinquency rate on FHA loans is running at 7.5%.  Taken together, it is very likely that more than one of every five FHA insured loans will default. How big is that tab and who picks it up?  Try somewhere between $50-$100 billion dollars and who do you think? That’s right, every taxpaying citizen in the country.

Congress has systematically changed standard FHA loans into nothing more than sub-prime loans circa 2009. How so?

1. The maximum loan size has been increased to $719k in high priced markets. That change was intended to be temporary but Congress could not help themselves and made it permanent.

2. The down payment on FHA insured mortgages is a gift-like 3.5%. Our loyal reader bonddadddy highlights the fact that many builders are rebating that down payment, thus turning this product into a no down payment product.

3. FHA allows closing costs and fees to be financed. Once again, our housing finance system has developed a product in which purchasers have little to no equity (no skin in the game).

How did this happen? Congress and the administration clearly saw the housing market going over the cliff. Thus in an attempt to shift the burden to the taxpayers and effectively give mortgage gifts to prospective homebuyers, we have a government subsidized mortgage product.

As the WSJ highlights:

A major lesson of Fan and Fred and the subprime fiasco is that no one benefits when we push families into homes they can’t afford. Yet that’s what Congress is doing once again as it relentlessly expands FHA lending with minimal oversight or taxpayer safeguards.

KD of 12th Street Capital made a similar comment earlier today. In regard to government programs providing subsidized financing for home purchases, KD wrote, “It’s utter BS….at some point they need to understand that some people can’t afford it.”

While pending home sales data rose 3.2% and drove our equity market higher today, what percentage of that number is driven by FHA “sub-prime” type mortgages?

We still have bills yet to pay.


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