As expected, an independent audit of the Federal Housing Administration, which currently insures more than $1 trillion worth of U.S. mortgages, released last Friday showed the agency in a massive financial trouble: Legally, the agency is required to keep capital reserves equal to 2 percent of the total book value of its single family mortgage insurance program, contained in the MMI Fund. But Friday's report indicates that reserves have in fact dropped below zero, to negative 1.44 percent.
The biggest factor? Bad loans made prior to 2010, and especially those made between 2007 and 2009, as the economy flailed and the housing market tanked. The volume of bad loans on the books is almost impressive: More than a quarter of the loans made in 2007 and 2008 were seriously delinquent as of this summer, as were 12 percent of 2009 loans. An independent estimate by Edward Pinto of the American Enterprise Institute says that more than 17 percent of all of the agencies loans were delinquent by the end of September.
It's not as if this news should come as a shock. Back in 2009, the agency's capital reserves were hovering near zero, and well below the statutory requirement, at just 0.53 percent. Since then, the total fund value has increased from $685 billion to $1.1 trillion. And reserves have dropped into negative territory.
Yet as The Wall Street Journal's editorial page reminds us, FHA leadership has been insisting all along that it's doing fine. Worries about its finances were "just plain wrong," according to Department of Housing and Urban Development Secretary Shaun Donovan, who oversees the FHA. "I can say undoubtedly that the FHA fund is playing a key role in the housing recovery and poses no immediate risk to the American taxpayer," he declared in 2009.
It's certainly a risk now. The agency is raising premiums in an attempt to avoid asking the Treasury department for a bailout. A Secretary Donovan is still dismissing worries that a bailout is inevitable. The reserve balances, he writes, do not "directly imply the need for any assistance from the U.S. Treasury."
That's only because the report actually understates the FHA's balance sheet problems. As The Washington Post notes in an editorial:
The FHA's predicament is worse than the $16.3 billion figure suggests. If interest rates remain low, more high-quality loans will be refinanced out of the FHA's portfolio, leaving the agency with the dregs. No one can predict these flows with precision, since the FHA also has a program to retain good-quality, refinanced loans. But the actuarial report suggests that protracted low interest rates could drive the FHA's capital reserve shortfall above $30 billion.
Donovan is like the ship captain standing at the top of the mast who continues to assure passengers that even though the vessel has taken on more water than it was ever designed to handle, the boat is still afloat—when in fact, the leak in the hull is bigger than anyone's willing to admit.