On Wednesday, the Federal Housing Administration was supposed to release its independent audit determining the soundness of the agency. Many have questioned that soundness because, as of Oct. 1, its reserve fund dipped below the required 2 percent of the agency's outstanding loans for the first time in its history. On Tuesday night, the agency abruptly canceled the release of that audit report, citing problems with the risk scenarios, according to The Washington Post.
Obviously, those problems stem from the fact that the independent auditors determined that the risks to the agency were higher than FHA Commissioner David H. Stevens has admitted to publicly. What's being questioned now is whether or not the FHA can rebuild its cash reserves without a bailout from the government. FHA has faced an increasing number of defaults as its loan volume expanded.
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, for which premiums are paid monthly by borrowers whose loan principal is more than 80 percent of their home's value, 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, or 2) an increase in the insurance premiums borrowers must pay at closing. Stevens, so far, has said he doesn't intend to use either option. Instead, he 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. The FHA has never had a risk officer in its 75-year history.
Even if he does none of these things, an internal audit showed that the agency's reserves will rebound in two or three years, so there may be no need for a government bailout. The internal audit used projections based on future home prices, interest rates and the volume and credit quality of the FHA's business.
The delay in releasing the external audit, done by Integrated Financial Engineering of Rockville, Md., was likely because it showed that the internal audit was too optimistic. According to the article in The Washington Post Thursday, IFE is running additional scenarios to test the accuracy of its final report. These additional tests would not have been requested unless the new report had concluded that the FHA faced greater risks to its solvency than previously reported.
Let's just hope that IFE is not just looking for a scenario that will match the FHA's internal audit and make its final numbers look better. It doesn't help anyone if the FHA continues to hide its problems until a bailout is desperately needed.
Lita Epstein has written more than 25 books, including Reading Financial Reports for Dummies and Trading for Dummies.
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