The carnage in the lending field seems to spread almost daily. The news is filled with reports of lenders who are losing money and going bankrupt, even though lending standards have tightened markedly during the past few months.
And then there's the FHA.
The Federal Housing Administration was started in 1934 in an effort to provide an alternative to private mortgage lenders. At the time most loans were five-year term mortgages, but the FHA popularized long-term mortgages and to compete private lenders had to offer similar products. Today term-loans are rare in the U.S., though they remain available in other countries.
By offering to insure loans with a longer term the FHA greatly stabilized the housing marketplace. Longer loans meant people would not have to scramble to refinance every few years, a huge advantage over the old system.
Under the FHA program today, lenders can make loans to borrowers who put down 3 percent of the purchase price and not worry if the loan goes bad: FHA insurance will cover losses.
By every standard the FHA program has been great for the country. HUD estimates that more than 34 million FHA loans have been originated, mostly to first-time and moderate income borrowers.
During the past few years, however, the FHA program has been in the doldrums while private loan origination volume soared. This occurred in large measure because the private sector could offer financial goodies unavailable to FHA borrowers.
For instance, you can't get an FHA mortgage with a stated-income loan application. You actually have to document your income under the FHA program, liar loans are not allowed.
Also, the FHA really wants 3 percent down while private lenders have been offering loans with nothing down. In fact, private lenders have been offering loans for more than the appraised value of the property, say 110 percent financing or maybe 125 percent.
And, of course, you can't get an option ARM from the FHA or an interest-only loan. The FHA only issues loans which make financial sense for both lenders and borrowers.
There is now a concerted effort to "modernize" the FHA program. The carrot is that larger loan amounts would be allowed and the FHA would permit loans with no money down. The stick? Mortgage insurance premiums would be based on individual risk rather than an identical fee for all borrowers. The result of risk-based premiums, says the GAO, is that 37 percent of current borrowers would pay higher premiums if they applied under modernization while for 20 percent premiums would not be a problem: They simply would not qualify for FHA loans under the new standards.
A growing number of legislators oppose FHA modernization.
Sen. Jim Bunning (R-KY) says he worries that "FHA reform is a back door way to shut down subprime lending. While we all agree that there have been problems in subprime, there has been strong market action to correct the problems, and the regulators have finally taken action too. If we try to shut down subprime by expanding FHA, not only will the taxpayers be exposed to risks that are not fully understood, but innovation and new product development, particularly for less creditworthy borrowers, will be stunted."
Another senator, Richard Shelby (R-AL), explains that "one lesson learned from the current pattern of defaults and delinquencies in the subprime market is that those borrowers with little or no equity in their home will be the most likely to fail. As we are already witnessing delinquency rates in the FHA's portfolio that mirror the subprime market, I believe we must approach any attempt to expand the program or lower the programs standards with great caution."
But the major reason FHA modernization may fail is very simple: The program is coming back in the marketplace.
After several years of falling volume, FHA activity is up significantly in 2007. As of July 15th, FHA applications are up 10.9 percent when compared with a year ago. That's a remarkable figure, given the turmoil in the lending field.
Rather than "modernizing" the FHA loan program why not stick with the program we have? It does have a high level of foreclosures, but then government programs are intended to help people, not generate a profit. It follows that a program aimed largely at first-time borrowers will have a higher loss rate than private-sector loan programs for the well-healed, programs that did not get 34 million people into houses.
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