Federal Housing Adm. Going Under? Who Knew?

Tighten your seat belts, here comes another disaster for taxpayer bailout. Hey, where was congress all this time? Who, if any body, was watching these guys?

Oh wait, this smells like a Barney Frank situation. "There is nothing wrong with Fannie and Freddie. Leave them alone."

Is Federal Housing Administration the Next Housing Bailout?
Source: Joseph Gyourko, "Is FHA the Next Housing Bailout?" American Enterprise Institute, November 11, 2011.

Given that the Federal Housing Administration (FHA) has not needed a direct recapitalization from Congress since its founding over three-quarters of a century ago, it is tempting to assume that the institution is perpetually stable. However, for the past two years, it has violated its most important capital reserve regulations, under which it is supposed to hold sufficient reserves against unexpected future losses.

However, the risk of unexpected losses has been chronically underestimated, allowing the FHA to leverage its commitments at astounding rates, says Joseph Gyourko, the Martin Bucksbaum Professor of Real Estate, Finance, and Business & Public Policy at the Wharton School at the University of Pennsylvania.

Aggregate insurance-in-force more than tripled in recent years, from $305 billion at the end of the 2007 fiscal year to just over $1 trillion according to the latest data available from July 2011.
The FHA's liquid reserves currently amount to $30 billion, which represents only 3 percent of its potential liabilities ($1 trillion). Furthermore, the corrected measures of credit risk suggest that the FHA faces default risks that are 50 percent greater than initially projected, amounting to approximately $13 billion in unforeseen losses.

For any institution to run at such high levels of risk and leverage, default would be a constant concern. Yet the FHA's problems are particularly acute for three reasons.

In their accounting methods for assessing risk, they have ignored or underplayed crucial variables that would have offered a much more accurate valuation of likely losses.
Additionally, the FHA has made guarantees on mortgages to numerous homeowners who are underwater in their payments -- underwater homeowners can cause financial stress and spark liquidity crisis in which losses cannot be avoided.

Finally, many of the assumptions made by the FHA about employment and housing prices in the near future, along with other macroeconomic indicators, are overly optimistic and paint a rosier picture of future finances than should be seen.