The Senate Banking committee is holding a hearing this morning to discuss the future of the Federal Housing Administration, after a November report revealed the government agency is in the red at least -$13.4 billion. Only Shaun Donovan, the Secretary of Housing and Urban Development (the department that oversees FHA) will be testifying today, but that shouldn't stop Senators on both sides of the isle from having plenty of time to Socratically expose FHA for the insolvent organization that it is.

FHA is like an insurance agency, for a fee it guarantees banks and mortgage investors that if ahomeowner misses his or her mortgage payments it will cover the bank's losses. It does not lend money directly to borrowers, but tries to help expand the amount of lending the private sector will do by back stopping their loans.

Secretary Donovan will say that all is well with FHA and no bailout will be needed. He is going to promise to raise the fee FHA charges lenders to guarantee they get paid if borrowers stop paying their loans. (Senators: "Why didn't FHA do that in 2008?") He is going to promise to raise premiums on existing borrowers. (Senators: "Why should borrowers currently making their payments chip in more to bailout an agency losing money because other homeowners are not making their payments?") He is going to promise to expand FHA's business and generate new money that way. (Senators: "Isn't that exactly what FHA has done since 2008, growing to 30 percent of the mortgage finance market, and yet they are still in the red?")

This morning I have an article in RealClearMarkets pointing out that no matter what FHA does it is going to be in the negative for a long time. At this point federal housing subsidy programs are like a half sunk Titanic, and no amount of bailing water is going to save the ship. We should just begin the process of shutting FHA down now:

the [FHA] 2012 actuarial report found that the housing agency's value has fallen $23 billion in the past 12 months primarily because of losses on mortgages it guaranteed from 2007 to 2010. And it is looking at a possible negative $93.7 billion valuation in the next five to seven years with those losses piling up.

About 25 percent of mortgages FHA guaranteed in 2007 and 2008 are seriously delinquent (90 days of missed mortgage payments or more), and more than 12 percent of 2009 mortgages are just a step away from foreclosure. (In normal times those numbers would be 5 percent or less.) FHA's own actuarial review estimates nearly $40 billion will flow out the door to cover losses related to these delinquencies.

What's more, notes Wharton School real estate professor Joseph Gyourko, FHA is currently leveraged 41-to-1 -- which is higher than either Lehman Brothers (31-to-1) or Bear Stearns (38-to-1) when they collapsed.

In case the Senators are a bit distracted by the fiscal cliff or a long Christmas shopping list, here are some more hard questions they can ask:

  • Is not true that we (Congress) have mandated that FHA reserve capital relative to at least 2 percent of the value of its portfolio? And doesn't FHA's recent actuarial report show its capital reserve is now negative 1.33 percent? Why should we not shut FHA down?
  • Didn't we learn in the crisis that bad lending standards were spread throughout the housing industry? And haven't many private firms have gone back to relatively more responsible lending practices (albiet plenty are still suspect)? And isn't FHA in contrast still guaranteeing loans with just 3.5 percent down payments, sometimes for borrowers with low credit scores and high amounts of pre-existing debt? So why should we trust FHA's promises to change now?
  • Why should current borrowers pay a cent more for their mortgages, when FHA is essentially an insurance agency for mortgage lenders and investors, who took the small but real risk that FHA might not be able to come good on its guarantee promises, and should be the ones one the hook for any losses FHA suffers? And while we are discussing fault, why should the taxpayers bailout FHA either? 
  • Isn't it true that in 2009 FHA promised that it would be worth a positive value in 2012? And isn't true that November's FHA actuarial report shows FHA is worth a large negative sum in 2012? And isn't it true that FHA now claims it will be back to a positive value in 2017? Wouldn't we be total suckers for believing you?

More from Reason on the failure of FHA here and here.