An in depth analysis of WHY YOU ARE WRONG

Tuesday, March 31, 2009

FHA Defaults Exploding

This is the problem. Nobody needs to use physical force or the threat of it( which is the only power government has) to get people to do things they see as in their own interest. In all markets in which coercion is banned, buyers and sellers meet in the middle at a price in which the seller gets the best available price from buyers who see the house as a good value. All parties, from the buyer to the lender who is taking on the loan risk have the incentive to look after themselves.

Of course the judgements of the marketplace often tell us things we don't like to hear. They might say that we can only afford a two bedroom home when we want one with four, or tell us we need to save a larger downpayment or even that we might be better off renting for now.

The current crisis developed after generations of government policies worked to convince more and more people that they had to buy homes they couldn't really afford. The primary mechanism at work was one of shifting risks further and further away from the primary parties involved, usually through the government "guarantee".

No need to wonder if your bank is making sound investments with your savings--- there's an FDIC guarantee.

No need to ask about larger amounts in huge institutions--- they are probably, too big to fail

No need for the bank to examine the buyers credit--- Fannie Mae will be buying and guaranteeing the loan or Freddie or the FHA etc...

The end result is a housing market filled with a huge number of people who bought homes they couldn't afford. The solution should be equally simple; just let homes fall to a price at which buyers can afford conservative downpayments of 10-20% and payments are no more than 20-25% of income.

Of course, this solution involves telling millions of people they likely overpaid for their homes-- something they don't want to hear.

So now, the house is on fire and the goverment cleanup crew is dousing it with a heavy dose of sober accounting and lending standards-- right? Well, actually they are thinking about telling banks to lie about the value of loans on their books.

They are being honest about which banks are in trouble so depositors don't give them more money to blow? Well, actually the fed and FDIC have refused to say which institutions are in trouble or which toxic assets the government has bought or guaranteed. They have done nothing to prevent troubled institutions from luring deposits with high interest rates.

But, they have worked to oust bad managements and punish frauds? Well, at this poiint almost all major firms are under the same management.

They are at least trying to toughen loan standards right? NO!, NO!, NO! The government is in fact working like crazy to reinflate the bubble by cutting loan standards again. The main mechanism for this shift is the massive growth in FHA loans which now comprise at least a third of the market.

We know for example that buyers who put down little or nothing for the downpayment were at high risk of default. So, why is the FHA making more loans of this type?

Another major red flag is the huge percentage of downpayments made by non-profit entities which are often funneling money from the seller for a fee.

"In 2005, HUD commissioned a study entitled “An Examination of Downpayment Gift Programs Administered By Non-Profit Organizations”. Later that year, another report titled “Mortgage Financing: Additional Action Needed to Manage Risks of FHA-Insured Loans with Down Payment Assistance” was completed by the U.S. Government Accountability Office. Both studies concluded that seller-funded down payment assistance increased the cost of homeownership and real estate prices in addition to maintaining a substantially higher delinquency and default rate."

The results of these policies are now bearing fruit-- defaults are exploding and so is likely fraud

"In the past year alone, the number of borrowers who failed to make more than a single payment before defaulting on FHA-backed mortgages has nearly tripled, far outpacing the agency’s overall growth in new loans, according to a Washington Post analysis of federal data.
Many industry experts attribute the jump in these instant defaults to factors that include the weak economy, lax scrutiny of prospective borrowers and most notably, foul play among unscrupulous lenders looking to make a quick buck.

If a loan “is going into default immediately, it clearly suggests impropriety and fraudulent activity,” said Kenneth Donohue, the inspector general of the Department of Housing and Urban Development, which includes the FHA."

The default rates are shocking.

"Add the percentage of FHA loans in the foreclosure process to the total loans that are delinquent at least one month and we have a total default/delinquency rate of 15.24%. Something is clearly wrong with the FHA loan program and another major bailout of a federal lending agency seems inevitable.

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