Although the FHA’s default rate has been climbing for months, the agency insists that it will not run out of cash. Unfortunately for the taxpayers who will ultimately be stuck with the tab if the FHA is wrong, this seems to be based on some questionable assumptions.
Certain things the FHA has done will improve its financial state. It is charging higher fees for the guarantees it offers, which means it will have more income. It is also increasing the down payment required, which should prevent some mortgage fraud and reduce the eventual foreclosure rate.
But ultimately, none of these will rescue FHA if the FHA is wrong about one thing.
That one thing is the FHA’s assertion that the loans in backed in 2009 are much, much better than the loans it was back in 2007 and 2008. That seems highly unlikely.
In the first place, the FHA’s book of business expanded at a pace that is truly breath-taking. Although we don’t have the final numbers yet, we know the FHA probably insured more than 2 million single-family mortgages in fiscal year 2009, compared with 1.2 million in fiscal year 2008, and 639,000 in fiscal year 2007. Meanwhile, the number of FHA staff grew by just 80 people last year.
Do you think that the FHA was really able to properly monitor for fraud and risk as the portfolio grew at that pace?
The FHA also thinks that a good part of the growth last year was among higher quality buyers. That is partly true—the average credit score is up to 690 from 630. But credit scores have proven an unreliable indicator for mortgage default rates. While people with higher credit scores are less likely to default than those with lower credit, that is a relative measure. It tells us nothing about the absolute likelihood of default.
In other words, the FHA is betting on a housing recovery. If mortgage foreclosures spike, the FHA could discover that people with a credit score of 690 in 2009 default at rates higher than people who had a credit score of 630 in 2008. That’s what it means to say that credit score is a relative predictor instead of an absolute.
There is good reason to doubt FHA’s assertion about the quality of its borrowers. Many of the borrowers were first time home buyers with brief (and therefore less reliable) credit histories. At one point last year, around 50% of all first time home buyers were having their loans backed by the FHA. Many of those buyers were able to purchase their home with almost no down payment—thanks to the home buyer tax credit.
We’d love to share the FHA’s confidence in the 2009 loans. But right now we think its misplaced.
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