By Pete the Banker

“The New York Times reports that a schoolteacher in Colorado recently got talked into buying a $134,000 fixer-upper with only 3.5 percent down. To afford that smidgen of equity, she liquidated her retirement savings. The bank rolled closing costs into the loan in return for a higher interest rate. Her monthly cost is 50 percent of her take-home pay.” (Here. )

The loan in question was an Federal Housing Administration (FHA) insured loan sanctioned under the Housing and Economic Recovery Act of 2008.

The FHA’s capital reserve level is now below the statutory minimum of 2 percent of its portfolio. According to a recent article, “Subprime Uncle Sam” in the Sept 29 Wall Street Journal,

“At a 50 to 1 leverage ratio, the FHA will soon have a smaller capital cushion than did investment bank Bear Stearns on the eve of its crash. (See nearby table.) Its loan delinquency rate (more than 30 days late in payments) is now above 14%, or from two to three times higher than on conventional mortgages. Its cash reserve ratio has fallen by more than two-thirds in three years.

The reason for this financial deterioration is that FHA is underwriting record numbers of high-risk mortgages. Between 2006 and the end of next year, FHA’s insurance portfolio will have expanded to $1 trillion from $410 billion.

Today nearly one in four new mortgages carries an FHA guarantee, up from one in 50 in 2006. Through FHA, the Veterans Administration, Fannie Mae and Freddie Mac, taxpayers now guarantee repayment on more than 80% of all U.S. mortgages. Sources familiar with a new draft HUD report on FHA’s worsening balance sheet tell us that the default rates have risen most rapidly on the most recent loans, i.e., those initiated or refinanced in 2008 and 2009.”

The FHA’s main lending problem is that it requires neither lenders nor borrowers to have a sufficient financial stake in mortgage repayment. Borrowers with little down payment and few if any closing costs have no equity in the home nor financial incentive to save their property if their financial condition deteriorates. Lenders protected by government guarantees bear little risk and simply extend or modify troubled mortgages or take back the secured home.

Why did Congress authorize the FHA under the Housing and Economic Recovery Act of 2008 to implement a loan program so similar to those of the failed CRA era? Given the massive delinquency levels displayed by sub prime loans, why is FHA underwriting low down payment, low cost mortgages so similar to earlier subprime loans. Why is the FHA pushing these loans despite it’s own accelerating portfolio delinquencies and the decline of it’s capital reserve? Will this program simply result in future mortgage market setbacks prompting additional federal government bailouts?