The big risk in the foreclosure fix
FHA, a formerly obscure federal agency, is now at center of many plans to fix the housing market. But it may not be up to the task - and that could cost taxpayers a bundle.
NEW YORK (CNNMoney.com) -- At the center of all of Washington's efforts to rescue the battered housing markets is the formerly obscure Federal Housing Administration.
But it's not clear whether the agency is up to the task or whether it will need a taxpayer-funded rescue of its own.
The agency currently backs $385 billion in mortgage loans, but that figure could double in the coming year if some of leading proposals in the White House and Congress go through.
"We are asking a lot of an agency that, prior to this year, had seen its market share shrink to almost nothing," said Jaret Seiberg, senior vice president at the Stanford Group, a Washington policy research firm.
"Now we're asking it to fill the gap left by not only subprime lenders, but to be the first choice [for many borrowers.] That is an enormous challenge."
Even FHA officials concede they don't know if the agency can handle the increased role. The FHA has been a small lifeboat helping a select group of home buyers, but it could be overwhelmed by the rush of new borrowers trying to climb aboard.
"That's a pretty good analogy," said Bill Glavin, special assistant to the FHA Commissioner. "It's pretty much uncharted water. We've never been asked to do these things before. We were already facing a lot of uncertainty, to be honest. It's going to be a whole new FHA, and there are going to be risks that go with it."
The FHA is a New Deal-era agency that helped create the modern mortgage market. The FHA program is intended for mortgage borrowers with weak credit or little or no cash, who may not be able to otherwise get an affordable mortgage.
Borrowers get FHA loans from private lenders, just as they would any other mortgage. FHA offers insurance to cover lenders if those borrowers, who pay a small insurance premium to the FHA every month, default on the loan. The FHA uses those premiums to cover the lender in the event of foreclosure.
During the housing boom in recent years, FHA's share of mortgages fell to only 7% of mortgage loans outstanding in 2007. Now that the mortgage market has collapsed, the FHA is suddenly the only choice for many borrowers and lenders.
"Many of the financing opportunities available to even prime borrowers have really been scaled back, through increased down payment requirements and [the requirement of] higher credit scores," said Corey Carlisle, senior director of governmental affairs for the Mortgage Bankers Association. "FHA is playing an important role providing stability."
And Washington wants the agency to shoulder even more responsibility.
About 150,000 borrowers have refinanced under a new program called FHASecure in the past six months. Launched in September, this program is aimed at subprime borrowers facing steep mortgage rate resets that they couldn't afford. That volume compares to the total of 425,000 loans the FHA backed in its previous fiscal year.
What's more, the loan limit on FHA loans was increased in March, which will further expand FHA's portfolio.
Two of the leading Congressional Democrats, House Finance Chairman Barney Frank and Senate Banking Chairman Chris Dodd, proposed legislation that would have the FHA back an additional $300 billion in refinanced mortgages, after the lender cuts the loan principal to 85% of a home's current market value.
Sen. Hillary Clinton has called for the FHA to take a direct role in buying, restructuring and then reselling underwater mortgages, rather than asking the lender to work out an agreement.
The Bush administration has yet to endorse as extensive a role for the FHA as leading Democrats are calling for, but it has signaled a willingness to expand the eligibility requirements for the FHASecure program for at-risk borrowers.
But Federal Deposit Insurance Corp. Chairman Sheila Bair acknowledged the risks inherent to the Frank plan in her testimony before Congress on Wednesday, saying no one knows if FHA premiums will be able to cover the increased risk of FHA's expanded mission.
"Losses that exceed the funds available in the reserve would have to be covered by taxpayers," she warned.
Those concerns were echoed by FHA Commissioner Brian Montgomery during the same hearing.
"The FHA should not be forced legislatively to compromise its fundamental criteria at the future expense of the taxpayer," he said. "The FHA currently is self-sustaining. As you know, few government programs can claim the same. We do not want to cross that line, particularly at a time when we are most needed."
The agency began backing increasingly risky loans even before this crisis hit. The cost of potentially bad loans insured by the FHA was estimated at $7.5 billion as of Sept. 30, up from $3 billion a year earlier and just $1.9 billion a year before that.
There are already signs that the FHA is overburdened. "We're hearing from members that getting FHA approval is taking longer," said Carlisle.
Some experts back the idea of making the FHA more aggressive, even if it will eventually require a taxpayer bailout.
"We sometimes refer to these proposals as stealth bailouts," said Seiberg, "because they don't necessarily require money today, but they may require funds down the road."
Seiberg and other economists agree that there's a risk of a taxpayer housing bailout no matter what FHA does.
"Congress may decide that it wants FHA to take more risk because it doesn't require [the government] to appropriate money up front, and it may not require money on the backside if we're able to turn this crisis around," said Seiberg.