FHA Commissioner Stevens Tells Us Not to Worry About FHA’s Cash Reserves

The Washington Post issued an alarming article today titled “Housing Agency’s Cash Reserves Will Drop Below Requirement.” In what seems like yet another case of “here we go again,” Federal Housing Authority (FHA) Commissioner David H. Stevens tells us not to worry about his agency’s dwindling reserves even as mortgage delinquencies rise.

The Post explains the importance and the role of the FHA (emphasis mine): “The FHA’s financial health is in the spotlight in part because of its key role in buoying the housing market. The agency lost much of its relevance during the housing boom when home prices soared and borrowers raced to aggressive subprime lenders. But after the subprime market collapsed, borrowers flocked back to the FHA, the only option for those who lack stellar credit or hefty down payments. Its historic role in backing loans is more crucial now than ever. The agency does not lend money; it insures lenders against losses. It has captured 23 percent of all new loans made so far this year, up from just 3 percent in 2006.

The FHA has been taking on risks other financial institutions have been unwilling to take and yet Stevens claims that “…the borrowers receiving recent FHA-backed loans have, on balance, been more creditworthy than those the agency is used to catering to.” And yet, in a few weeks, the FHA’s cash reserves are projected to fall below the 2% minimum required by Congress. (Yes, I was shocked to learn that the minimum is this low!!!). Sure, the mix of borrowers has improved because other financial institutions are only cherry picking the best of the best borrowers, but this does not improve the credit-worthiness of the high-risk borrowers the FHA continues to accept.

In the face of this looming crisis, Stevens assures us that there are several measures he will be putting in place to avoid having to go to Congress pleading for a bailout. I recommend reading the article (or looking for his official announcement) to get the entire laundry list. I want to focus in on what I consider the most dangerous components of what seems to be happening here.

First, the fact that the FHA’s finances have deteriorated as it takes on a greater burden in the housing industry is a potentially strong sign that the agency is likely not up to the Herculean task ahead of it. Indeed, Stevens assumes that reserves will bounce back up to required levels within 2-3 years as the housing market recovers in those years. However, FHA projections and assumptions are likely too optimistic. Indeed, the housing recovery will most likely be weak, and the market may not even bottom until as late as 2013. In the meantime, the FHA may very well remain in violation of its requirements and remain exposed to a disastrous default (of course the government will rush to the rescue before that happens).

Stevens also claims that forcing lenders to take on a greater financial responsibility for mortgage fraud will add to reserves. This is a bizarre argument. I can understand how it will stop the bleeding, but not how it will ADD to reserves in a significant way. Regardless of the real math, we should all be very concerned that fraud is a big enough issue that controlling it could be considered a material benefit to reserve levels.

Finally, Stevens plans to hire a risk officer by the end of the year. By the end of the year!? The Post states that plans were already underway to hire a risk officer before the current audit, but I was blown away to learn that this kind of agency has no such person already in place…especially with the flood of new RISKY business coming its way. Until that person is hired, we have no reason to believe any projections that come out of FHA regarding the health of its cash reserves in the current economic environment. We certainly cannot remain complacent and/or assume that the planned measures will solve the problem.

It will be important to keep an eye on the FHA’s operations in the coming months as the housing recovery sputters, twists, and turns. The Post tell us that “…the agency’s sudden popularity has alarmed some lawmakers, who regularly question whether the FHA has the resources and expertise to handle its increased workload and avert an avalanche of new defaults.” I share their concerns.

Be careful out there!

Full disclosure: long puts in XHB and short TOL

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