As of Oct. 1, for the first time in its history, the Federal Housing Administration (FHA) will see its cash reserves fall below the two percent minimum mandated by Congress. The cash reserve numbers were calculated as part of a required audit due out this fall, according to a report in The Washington Post. (I discussed this likely possibility two weeks ago.)
The FHA's cash reserves are built with the insurance premiums home buyers pay when they close on an FHA loan. While private mortgages are insured using Private Mortgage Insurance (PMI) premiums paid monthly by borrowers who don't put down at least 20 percent on a home, FHA insurance premiums are paid in full at the time of closing. The insurance premium is usually folded into the mortgage and paid over the life of the loan.
The FHA essentially has two options to raise cash: 1) a government bailout and 2) an increase in insurance premiums borrowers must pay at closing. Neither of them looks likely and FHA Commissioner David Stevens told The Washington Post he doesn't intend to use either option. Stevens believes it's politically impossible to get bailout funds passed by Congress at this time and he doesn't want to hurt the weak housing market by making it more expensive to buy a home.
Stevens thinks he can fix the agency's problems of beefing up reserves using other tactics:
* He plans to propose that banks and other lenders that do business with the FHA have at least $1 million in capital so they can repay the agency for losses if they were involved in fraud. Currently they only need to have $250,000 in capital.
* He plans to propose that lenders take responsibility for any losses due to fraud committed by mortgage brokers with whom they work.
* He plans to hire a chief risk officer. This FHA has never had a risk officer in its 75-year history.
Even if he does none of these things, the audit shows that the agency's reserves will rebound in two or three years, so there may be no need for a government bailout. The audit uses projections based on future home prices, interest rates and the volume and credit quality of the FHA's business.
With its new role backing loans that include more credit worthy individuals, the FHA's borrowers are now more credit worthy than in the past. The agency backed 23 percent of all new loans made in 2009 versus just three percent in 2006. During the housing boom, when money flowed freely with zero down subprime loans easily available, few people turned to the FHA. That's no longer true.
The FHA does not make loans, it insures lenders. But it's the higher level of insured loans that has some in Congress concerned that the FHA may be getting in over its head. They wonder if the FHA is prepared to handle the additional workload and whether this drop in reserves could turn into an even bigger problem in the future requiring a bailout. For now the answer appears to be no. But it's worth wondering whether the housing market has truly hit bottom and is on the road to recovery. If not, the FHA could be in for a rough ride.
Lita Epstein has written more than 25 books, including The 250 Questions You Should Ask about Buying Foreclosures.
Federal Housing Administration running low on cash