FHA’s 30x leverage on mortgages is creating a new "subprime" market
by Sober Look
The U.S. Federal Housing Administration (FHA), who continues to provide (via insurance) 30x leverage on mortgages by requiring only a 3.5% down-payment, is having a rough time. The loans the agency has been insuring are seeing worsening delinquency trends.
Reuters: – Fitch Ratings sees a growing divergence between 90-day past due delinquency patterns for guaranteed and nonguaranteed loans as a potentially troubling signal of future losses. This may eventually force the FHA to look for opportunities to put back some defaulted loans to the banks, particularly if the agency’s funding status worsens and U.S. home prices fail to rebound quickly.
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For eight of the largest U.S. banks with substantial portfolios of FHA-guaranteed loans on their books, combined 90-day past due delinquencies totaled $79.4 billion at June 30. Of that total, 83%, or $66.0 billion, represented government-guaranteed mortgages.
This highlights the dimension of the growing delinquency problem for the FHA, given the predominant position of FHA-guaranteed loans in the troubled asset categories of major banks.While delinquency rates for nonguaranteed loans have been improving steadily at these institutions, the trend for FHA-guaranteed loans is starkly different.
In the spring the agency increased its premiums to insure mortgages by 75bp to 1.75% – which is still materially below market, particularly given the extremely low equity the borrower ends up having in his/her house. These FHA guaranteed mortgages are today’s version of the “subprime” market.
Reuters: – With many FHA-guaranteed loans in a negative equity position, the low required down payment of 3.5% for qualifying borrowers is likely to exacerbate default and delinquency trends over time, as borrowers have reduced incentives to continue making payments.
Since there is no appetite in Congress to bail out the FHA as its financial condition deteriorates, Fitch believes that the FHA may end up renegotiating its full protection on these mortgages with the banks who hold the loans. The agency may in effect default by paying less than its original principal protection – thus transferring some of the loss to the banks.
Reuters: – Absent a quick turnaround in delinquency and foreclosure trends, and assuming Congress will have little appetite for an FHA bailout in 2013 or later, we expect the FHA to evaluate unconventional methods to boost reserves, potentially including a more aggressive stance vis a vis banks over full insurance coverage of defaulted mortgages
If that were to happen, banks would simply refuse to participate in FHA’s insurance programs going forward and the FHA’s whole reason for existence will be in jeopardy. Maybe the madness of 30x leverage on mortgages will finally come to an end.
The two things that would end instability of the housing markets would firstly be regulations on leverage by end users and deposits. If mortgages could not be higher than 3 times salary and need a 25% deposit the banks would be unable to leverage a new property bubble. This could preclude the need for an FHA, as borrowers would have skin in the game.
Secondly end securitisation. This would leave banks with the loans on their books. It would end issues about who has the right to foreclose and would give incentives for the banks to ensure the loan was repaid. By allowing securitisation banks had no incentives to do that and the sub prime market grew. If banks need funding then issue bonds on the bank, rather than the loan.