The New York Times has an article about the woes at the FHA which has enough omissions of relevant history so as to render it misleading at points.
Mind you, the main message of the story is sound, namely, that the FHA, long a mainstay of lower-income housing, is suffering increasing losses, because it has been pressured to take a bigger role, which these days is code for to “lower lending standards to prop up the housing market”:
Problems at the Federal Housing Administration, which guarantees mortgages with low down payments, are becoming so acute that some experts warn the agency might need a federal bailout….
In testimony before a House subcommittee, the F.H.A. commissioner, David H. Stevens, assured lawmakers that his agency would not need a bailout and that it was managing its risks.
But he acknowledged that some 20 percent of F.H.A. loans insured last year — and as many as 24 percent of those from 2007 — faced serious problems including foreclosure, offering a preview of a forthcoming audit of the agency’s finances….
Since the bottom fell out of the mortgage market, the F.H.A. has assumed a crucial role in the nation’s housing market….The government is giving as many people as it possibly can the chance to buy a house or, if they are in financial difficulty, refinance it. The F.H.A. is insuring about 6,000 loans a day, four times the amount in 2006. Its portfolio is growing so fast that even F.H.A. backers express amazement.
What bothers me about the piece is that it implies that the losses are due to the low down payments:
In the aftermath of the crash, there is wide divergence on how easy, or how hard, it should be to become a homeowner. Skittish lenders are asking for 20 percent down, which few prospective borrowers have to spare. As a result, private lending has dwindled.
The government has stepped into the breach, facilitating loans with down payments as low as 3.5 percent and offering other incentives to stabilize the market. Real estate agents in some hard-hit areas say every single one of their clients is using the F.H.A.
What is wrong with this? The FHA has ALWAYS been in the low down payment business! It has long offered loans requiring only 3% down, long before “subprime” was part of the lexicon. Historically, FHA loans did not show default rates materially worse than prime loans. That experience has been replicated by not for profit lenders in low income neighborhoods.
In fact, when subprime became a big business (the post 2000 incarnation; there were subprime mortgages in the 1990s, but those were mainly for manufactured housing), it first took share from FHA and then expanded the market. And the big difference from how the FHA once did business versus its subprime competitors was…..the FHA screened loans on an individual basis. The process was time consuming and somewhat intrusive. Private lenders were faster, easier, and (lo and behold) less stringent.
My objection is that the article implies that low down payment loans are a bad idea. They aren’t necessarily. Low down payment loans can be a viable business, but lenders need to screen borrowers much more carefully than when they have a much bigger loss cushion.
And using low down payment loans as a way to prop up the housing market IS a bad idea. The fact that the FHA is cranking so many loans through more or less the same administrative platform is strong evidence that its lending standards have gone out the window.
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Trillions of dollars wasted on a desperate (and ultimately futile) attempt to manipulate the market and keep housing prices out of reach of the very people it pretends to help.
Deliberate losses by people who don’t think bad loans are bad.
Deliberate dilution of the very notion of property.
Madness has become the policy.
Low down payment is not the issue. Low down payment for housing “investors” is the problem, in my mind.
http://www.hud.gov/offices/hsg/sfh/lender/sfhmolin.cfm
HUD is a festering pile. Cuomo used to run it(97-01), now he’s searching for redemption with the NYS AG office?
http://www.villagevoice.com/2008-08-05/news/how-andrew-cuomo-gave-birth-to-the-crisis-at-fannie-mae-and-freddie-mac/1
Don’t agree with all of the conclusions of the above, and would never give Mr. Cuomo that much credit, but a good history of the timeline and some of the players.
This guy has some good commentary on these issues.
Note this part:
Some random comments on credit conditions:
-Among subprime adjustable-rate mortgages, nearly 40 percent are seriously delinquent.
We really ought to string someone up over this number. A 40% default rate is not bad judgment. It is a crime.
Thanks for the link, eh. Great stuff.
As far as framing the issue, I don’t think anyone does a better job than Bill Black.
Somebody (I think it was Ed Harrison) linked Bill Moyers interviewing Bill Black the other day:
http://www.pbs.org/moyers/journal/04032009/watch.html
If you happened to of missed it, Black’s performance is absolutely outstanding. I think Black’s great gift is his ability to bring this stuff down to a level that pracically anyone can understand. Things that the “rapers and pillagers” (also known as the “best and the brightest”) try to make too complicated for the rank and file to grasp are suddenly not so difficult to understand anymore.
The problem is that you can’t insure high-LTV loans in a down market at the exact same premiums as in a healthy market. Insuring jumbo high-LTV loans at the same premiums as the FHA has recently is just asking for disaster.
The FHA’s risk model simply doesn’t exist. They know there is no risk aside from the risk to the taxpayer and that’s how it is run.
It is fact that high-LTV loans have higher default rates. That effect is exacerbated by rapidly falling prices like we’ve seen since 2006 and we’re putting that risk on the taxpayer now.
Here’s my view on it: http://homeecblog.wordpress.com/2009/10/08/house-hearing-on-fha-capital-reserves/
A criticism of legislation is that it is often verbose and complex and poorly enforced.
In the spirit of Occam’s Razor – possibly the simplest legislation to prevent credit crises like the current one is:
All housing loans must be 80% LTV or less and NO vendor financing or 2nd liens.
Now that would have stopped the housing market bubble before while it was a baby froth.
Yes. Well, “in theory” home prices never decline. With only 3% down, or less, a buyer (debtor, really) has nothing but the hope of appreciation so they can recover all that interest. When that vanishes, people walk away. Understandably.
Prudent lending required a substantial down payment for sound reasons.
Not everyone ought to be a homeowner.
Just cannot get these replies to show up in the right place. The above was meant as a response to the comment below — “in theory”.
Although in theory I think Yves is right – that there’s not anything wrong with a 3% down home loan – in practice the FHA seems to be making bad loans. Denninger lays out stats here:
http://market-ticker.denninger.net/archives/1451-CORRUPTION-Government-Housing-Programs.html
Even if you support the putative mission of HUD and FHA, which I do (at least on paper), I don’t think it is in anyone’s interest to make loans that are known to be likely to default, and quickly.
More railing here, as grist for debate:
http://market-ticker.denninger.net/archives/1498-Corruption-FHA-Is-Dying,-Will-Anyone-Stop-It.html
Can someone provide me with the address to Galt’s Gulch, please?
It is right around the corner from the perpetual motion machine John Galt invented.
What is wrong with this? The FHA has ALWAYS been in the low down payment business!
But real estate prices have always been rising nationally until the crisis. Without any “skin in the game”, there is little incentive not too default if the house is in negative equity. If there is no skin in the game, there is plenty of incentive to get free housing for 2 years or however long it takes to get kicked out.
Yves,
Your article is basically saying that the issue is not the down payment but the underwriting guidelines are being compromised.
I don’t see this. Income veri is there, credit scoring has not changed. Quality of home is still there.
I guess my point is that there defaults are not because of changed underwriting. The increase in defaults is simply a underwriting that does not work in this environment. The reason is not that they are getting lax, its because they are not tightening up enough given the current economic conditions.
Bottom line, there underwriting worked in normal markets, but now it is to loose. But it hasn’t changed.
“Bottom line, there underwriting worked in normal markets, but now it is to loose. But it hasn’t changed.”
That’s exactly one of the huge problems. An insurance company that doesn’t price based on risk… what kind of model is that?
If low down payments were not problematic you would not need the government to offer them in the first place.
Of course it used to go fine, prices were going up. 40 to 1 leverage at banks used to go fine as well.
Folks, I pointed out that the FHA got crowded out of the market in the post 2000 period by subprime, which had far more lax standards. FHA mortgages also include the cost of insurance in payments, BTW.
I am not able to find the history of the 3% mortgage product quickly, but I am pretty certain it dates back to the 1980s, if not earlier. These were not period of robust home price appreciation. Housing prices were soft both in the Volcker recession, and in the 1990-1001 recession, and did not start picking up until a couple of years after that (that housing downturn was 15 quarters, peak to trough).
Comparing the FHA now to the FHA then is clearly apples and oranges. The FHA has basically been asked to refi as many not-privately financeable mortgages as possible. This is different from its historical mission, of helping low income and young people who had good prospects of meeting their obligations buy a first home.
Home prices did not appreciate in the 80’s? From what I know they had huge bubbles in some local areas.
Anyway even let’s pretend they were stable, it is still a HUGE difference from now when they are crashing. You can do all the screening you want, it doesn’t make any sense to keep paying your mortgage when you are hugely underwater, you have a free option to walk away, and you can rent a similar house next door for half as cheap.
Your comments on the so called FHA’s mission to make homes affordable for low income families are non sense. This is simply ridiculous. The mission of the FHA is the same as the mission of Freddie Mac and Fannie Mae: prop up house prices at taxpayer’s expense.
Just compare the homeownership rate to that of other countries. No other countries government’s are insuring half of the mortgage market. Even the socialist republics of Europe (I am French). The homeownership rate is the same.
True, there mission has changed. But we are not dealing with different underwriting.
simply put, underwriting real estate is based on 3 things. The triangle of real estate underwriting.
1)LTV. We know where this is
2)DTI. Of course what matters here is veri(which they do), then what percentage. Now normal guidelines are 42% of total income(including all other payments reporting on credit file). This is considered to be conservative as standard for most private mortgages is 45%. However, FHA allows exceptions all the way up to 55% LTV. This is where it gets tricky. Who gets the exception? Right now with the deals I’m doing, you can pretty much count on anyone getting it. Exceptions to DTI are NOT credit driven, or so it seems. But, to stick with this story, has that changed? I work with brokers that have been in the industry for 30+ years doing mortgages. FHA is now a automated system. They don’t have eyes on every deal. They used to though. But the exceptions to 55% DTI aren’t new. There just done by a computer system.
3)Trust(Credit Score) 620 minimum. No change here. Also, no credit needed as long as you have record of utility.
I guess my point is, there are many factors to take in. Sure, I can feel confident that more exceptions are made right now to DTI. That is part of it. But a soft real estate market and some markets that are going through 60%+ corrections are two very different things. To me, there is more to this then lax underwriting. Its what normal underwriting needs to look like. Average income americans can not afford 42%DTI. It is simply to steep for what they need to spend the rest on short of major sacrifice. And although we may be coming to that place where “needs” are redifined, were not there yet.
Bob,
I differ with you on your item 3), and that is precisely what is wrong with our current process. Simple numerical scores are a lousy proxy for ability to repay. It is a function of job skills and stability (which are not under the borrower’s control, here is where knowledge of local community, stability of local employers and ease of borrower getting new job at roughly comparable income is key).
The widespread use of scores is a mid 1990s phenomenon, driven by….securitization! Old fashioned lenders hated it but were forced to go along.
The not-for-profit lenders that have showed great success in lending to low income borrowers make sure they do budgets and see how their fully loaded housing costs fit with their income. A fair number of prospective borrowers reportedly withdraw when they see the implications. I do not know when FHA switched, but historically, it also had a hands-on, one-on-one process through at least the 1990s which also involved looking at the household budget (not as detailed as the not for profits) rather than a FICO score.
You are right Yves. I had experience with FHA as a Realtor and a loan officer. I also knew the old way of packaging loans, where not only was everything done in writing, but there wasn’t a score on the credit. In the case of FHA, they were more concerned with how much money was left after the person made all their payments than anything else. In fact, I don’t recall in my early years that they had much of a debt ratio system, but used this residual income as their basis for making a loan. There were other things though about FHA then that people pretend didn’t exist. You could finance closing costs and in essense get nearly a 100% loan. I recall in the old days when the maximum loan was $45,000, they would finance 97% of the total acquisition costs of the first $25K and 95% of all up to the $45,000 maximum. My memory is foggy as to what the later loan limits were, but the 97% of the first $25K was a constant for a long time. My experience goes back to 1976 in this matter as an agent. I was in a market at the time that it was imperative that you knew how to qualify an FHA and how to fill out the contract.
There are some old wives tales about LTV’s as well. We have had 95% FNMA loans since the early 1970’s, when MGIC or one of those outfits invented PMI. I am sure they copied the experience of FHA and VA in order to create their model. What they also copied was the default rates of the 1950’s and 1960’s before the government destroyed the medical business and consumer credit became prevalent. It was the high end market that didn’t have high LTV financing, something I believe RFC solved in the early 1980’s. RFC was a partnership between Norwest Bank, Soloman Brothers and I believe quite possibly GMAC. I do believe that GMAC bought RFC. The 95% loan limits on RFC money was $150,000. I believe FNMA was limited to $108,300 at the time and RFC would do a 90% loan to $250K. Because the limit at the time was pretty much dictated by the PMI companies, other outfits did 90% or higher loans as well. It was the PMI companies that at first created the high LTV conventional loan. During the 1980’s, higher losses came out of the woodwork and PMI rates went up.
I would guess that PMI companies has as much to do with credit scores as the securitization system. It was PMI that told the industry what it would insure, not the other way around, just as the FHA tells GNMA what it will insure. GNMA, the secondary market and FNMA/FHLMC merely accept insurance in lieu of downpayment.
So we have reached the crossroad. The crossroad is what is needed as skin in the game or surety to make a mortgage? We are about to find out as the bankruptcy of the insurance system is as certain as sunrise. I would be shocked if a PMI company would underwrite a 95% loan, as I recall you couldn’t get one in DFW back in the later part of the 1980’s. I have heard that FNM or the mortgage company themselves were insuring individual loans. I do believe that FNMA only insured the pools against loss, but I could be wrong. I have to believe the MI companies ae insolvent, though I do know that much of the stuff at the end of the bubble was covered by a piggyback second, something I was somewhat involved in popularizing here. This is one reason I find it amusing that WFC is considered to be solvent, as they were monsters in this business.
I read enough of that report to see the questioning of why the number of foreclosures had been increasing since the mid 1980’s. LTV was clearly one reason, but far from most peoples minds when we had a raging stock bubble in the late 1990’s was that loan delinquencies were at record highs. This, despite free money and shrinking unemployment.
It has occurred to me that the worldwide deflation may have begun at the peak of the Japanese market and only the leverage of housing in the US and later around the world prevented a worldwide deflation. I had read where Europe had one hell of a time getting out of the hole in the 1990’s, evidence of a deflation themselves, but they hadn’t bid housing to the moon. Housing in the US was aided by falling mortgage rates that in essense allowed for easier qualification as time went on. As the stock market created a bubble mentality, especially with those that got out with the huge gains, it merely moved to housing where easy finance made it quite easy to leverage gains to massive potential over only a short time. This destroyed the affordability, but it did one more thing. It piled on more dollars of debt.
I contend from thinking about this subject over time that the real cause of delinquencies and foreclosures has been that the real effects of deflation have been with us for a long time. The real effect is that debt becomes increasingly difficult to pay. What we have confused is debt service with the amount of debt. The amount of debt is going to always overwhelm a society over time. Even if the interest rate was zero, the disparity between those that owed and spent on other things and those that owed and paid back would be enough to create the basis of default. Once housing became the real source of most credit increase, it also became the source of default.
What is to be learned out of this idea is that debt will be increasingly difficult to pay whether the government forces debt into the system to keep it going or not. We have had enough inflation of credit over the past 20 years to realize this matter is different than what is assumed in most text books. Now that we have entered the next stage of deflation, which we have, most debts incurred will rapidly become bad debts. It should not only get harder to get credit, but I believe the entire system, including those in government are going to suddenly realize that what they are doing is creating a bigger pile of bad debt going forward. By this I mean a bigger pile in dollar volume and in percentages, as more and more additional lending will prove to be bad debt. This is 180 degrees away from Irving Fishers theory of debt deflation, which is the model being followed by Ben Bernanke and our government and most of the rest of the world as well. I would suspect the US is in a more difficult spot due to the fact its banking system fueled demand worldwide and for that matter is the backbone of the worldwide credit system. We are going to see a deflationary reaction to this.
Yves,
I agree with you 100%. Although I would say that a budget and knowing confidently that a client CAN repay is the DTI, not a trust factor. And that is really what I was trying to get to in my post. DTI is so unique to each borrower. Sure, you can put the blame on the individual(which I certainly do) for not doing there own budget. But if you run a company that lends money, you need to know if they can repay, not throw some magical number out there. And that is where automation, securitization have failed us. See, they took a number that was an average for loans, created a “standard” and off to the races. The problem is it can’t adapt to different environments until you know the
“standard” is no longer sufficient. i.e., increased defaults. It is a model of loaning money that will fail everytime. Because as soon as the standard fails, the loans are already on the books. It’s to late.
So in the end I agree with you and disagree. It’s not that FHA is getting loose. There simply using a model that is based on a constant that NEVER stays constant. Without individual underwriting and holding loans on the books with accountability at a personal approval level, no system will last. It will eventually fail for when you see it fail, the money is already gone. Prevention is impossible.
What about those who strategically default? If one can get a house with 3.5% down (or potentially 0% down with the $8k tax credit), what’s to keep one from defaulting just because his/her mortgage becomes seriously underwater even if the payments are affordable? Adequate down payments (20% like it used to be) are a necessary, but not sufficient, condition for a stable housing market, IMHO.
REF:
http://www.latimes.com/classified/realestate/news/la-fi-harney20-2009sep20,0,2560658.story