Bush’s FHA Band-Aid

The Bush Administration, which resisted proposals to have Fannie Mae and Freddie Mac buy more mortgages to alleviate stress in the housing markets, is instead looking to the Federal Home Administration, which traditionally has provided insurance to low and middle income mortgages, to help troubled borrowers.

But if you believe the data in the Wall Street Journal story, this move is likely to prove inadequate. The Journal reports:

But many buyers who got subprime loans are beginning to have trouble making their mortgage payments as the attractive initial “teaser” interest rates are reset at much higher levels. While many of those buyers believed they could refinance their loans, that has become much harder as mortgage lenders tighten their standards in the face of defaults and foreclosures. The Center for Responsible Lending estimates as many as 2.2 million loans will reset over the next two years.

FHA says it is constrained from doing more now because of limits on the size of the loans it can back and some requirements that borrowers must meet. While its refinancing business has picked up and the agency expects to refinance about 120,000 loans this year, FHA officials say they could easily double that amount if given greater flexibility.

Do the math. As many as 2.2 million loans will reset over two years, so that’s 1.1 million a year. That doesn’t include borrowers who are already in trouble, or are stressed in the absence of a reset. As Dean Baker points out:

…..many of the subprimes were seriously delinquent or in foreclosure long before the mortgages reset to higher rates. In an analysis done early this year, the FDIC found that 10 percent of the subprime adjustable rate mortgages issued in 2006 were seriously delinquent (missed three or more payments) or in foreclosure within 10 months of issuance.

Since no mortgages had reset at the 10-month point, clearly there were other problems. Either borrowers could not afford even the low teaser rates or they were defaulting because they realized that their homes were worth less than their mortgages. The latter problem will only get worse as house prices continue to decline in response to the glut of housing on the market (the inventory of unsold new homes is 50 percent above the previous record and the number of vacant ownership units is almost twice the previous peak) and tightening credit conditions curtailing demand.

Now as we have discussed, the stats on delinquencies are notoriously unreliable (foreclosures are a different matter, but by then, things are past the point of no return). So we have to make guesstimates. One data point was a March report by CreditSights that estimated 500,000 homes could be coming on to the market due to subprime problems. Remember, those are the ones that hit the wall; there are more that are still in trouble. And conditions have deteriorated since March.

So let’s take that 500,000. Add to it a percentage of the 1.1 million borrowers assumed to undergo a reset this year (for the purposes of this exercise, per Baker’s point, we’ll assume the two populations don’t overlap, even though we know that isn’t really true. Nevertheless, the 1.1 million understates the total of borrowers at risk by a large but unknown margin), say 25%, who become seriously delinquent (that’s if anything low).

So if the FHA gets its authority to increase its scope, it could handle 240,000 mortgages a year, which by my very rough calculation is 31% of the mortgages at risk (anyone with a better methodology or data please speak up).

But remember, we are dealing with full year 2007 values when we are two-thirds of the way through the year. The number of borrowers under stress will tend to rise as weak homeowners keep trying various means to hang on to their homes. And other analyses show that more mortgages will reset in 2008 than 2007. So one would expect that the later the program is implemented, the greater the number of borrowers who will be in need, hence the lower the proportion that can be helped.

And even this proposal may well be cut back. Again, from the Journal:

But not everyone is convinced, and FHA reform may run into trouble in the Senate. Alabama Sen. Richard Shelby, the ranking Republican on the Senate Banking Committee, has expressed concern about expanding FHA, saying it could ultimately hurt taxpayers.

“One lesson learned from the current pattern of defaults and delinquencies in the subprime market is that those borrowers with little or no equity in their home will be the most likely to fail,” he said at a hearing last month. “We must approach any attempt to expand the program or lower the program’s standards with great caution.”

So much for compassionate conservatism.