Is FHA the Next Bear Stearns?

Will the Federal Housing Administration be the next "too big to fail" colossus to need a taxpayer-funded federal bailout?

That's the question asked in today's Wall Street Journal, noting that the FHA currently has capital ratios that are more out of whack than investment bank Bear Stearns did before it went under last fall. Bear Stearns' capital ratios were 33 to 1, while FHAs are currently 50 to 1.

The Journal argues that taxpayers could be facing losses of $100 billion or more if home prices continue to fall in states like Florida, Nevada or Arizona.

According to Guy Cecala, CEO of Inside Mortgage Finance, 90 percent of FHA borrowers are just making the minimum down payment, currently 3.5 percent

"Virtually all of the loans made last year under this program are most likely under water," says Cecala, as home prices have dropped in most areas across the country by 5 percent or more.At the same time, the FHA was born from the Great Depression, when no banks were willing to make these kinds of loans. According to Cecala, FHA has a public mission historically that justifies it making low down payment, affordable mortgages.

More recently, the FHA loan process was viewed with disdain by most borrowers, as many private lenders would do zero or 1 percent down mortgages with much less paperwork.

The editorial staff at the Journal makes two arguments to reduce taxpayer exposure to FHA:

1) That the down payment requirement should be raised to five percent, although it's debatable what difference that would make. If the minimum down payment on a $200,000 house went from $7,000 plus closing costs to $10,000 plus closing costs, you would certainly eliminate a percentage of potential buyers.

2) That lenders (read "banks" and "brokers) should be responsible for some percentage of losses, perhaps as much as the first 10 percent, to create an incentive for them to lend more responsibly.

Considering some of the signs that the housing market has far from rebounded, the timing of the Journal's warning cry seems odd, but the federal government is going to have to figure out which levers to pull and which ones to leave alone as it weans the economy and the housing market off the fire hose of low interest rates, tax credits and federal guarantees.
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