For FHA, a Huge Task and Uncertain Role

As Proposals Put Onus on Agency to Aid Homeowners, Its Officials Cite Great Risk

The Federal Housing Administration has a big new role to play in untangling the mortgage mess, but even the agency itself does not know whether it can or should handle some of the tasks it is being asked to perform.

After steadily losing relevance and customers to aggressive private lenders during the housing boom, the FHA is being asked to "pick up the pieces," as one official put it, for strapped borrowers.

Just about every major housing proposal has the FHA helping refinance troubled borrowers into its government-backed mortgages. By doing so, the agency would take on even riskier loans than it is used to handling.

Whether it should do that may be more of a philosophical issue than an operational one. But if the agency fails, many fear that taxpayers will take a hit. The proposals come at a time of financial stress for the FHA. For the first time in its 74-year history, it may need taxpayer money to fund its flagship home-buying program next year.

The House expects to vote today on a package that would dramatically expand the FHA's role in responding to the housing crisis. The package also includes a long-awaited measure to modernize the agency and increase the size of the loans it insures.

The Bush administration supports FHA modernization but yesterday threatened to veto the FHA expansion championed by Rep. Barney Frank (D-Mass.). The federal government "should not be the lender of last resort, with the private sector dumping bad loans on FHA," said Roy A. Bernardi, deputy secretary of the Department of Housing and Urban Development, which includes the FHA.

Some lawmakers have raised similar concerns. Sen. Patty Murray (D-Wash.), who heads a Senate panel that oversees housing appropriations, said Congress needs to "get real" about the FHA's ability to manage more troubled loans.

The FHA does not lend money directly. It provides mortgage insurance to borrowers through private lenders. Traditionally, those lenders have considered only borrowers who have at least 3 percent equity in their homes and who can document their income.

Since its creation in 1934, the program has been self-sustaining, meaning no public money has been used to cover its losses. Instead, FHA borrowers pay premiums to cover defaults and foreclosures.

Those premiums are kept in a reserve fund, which totals more than $21 billion, according to the FHA's independent auditor. By that measure, the agency is financially sound. Some who track the FHA say its finances should improve as it wins back its bread-and-butter customers -- first-time home buyers, minorities and low- to moderate-income families.

When house prices soared, those borrowers turned to more affordable subprime adjustable-rate loans, many of which did not require down payments or income verification. When values dropped, defaults increased and subprime loans just about vanished. A credit crunch ensued, and demand for the FHA's vanilla fixed-rate mortgages grew.

The number of FHA loans issued for home purchases and refinancing shot up 126 percent in the first quarter of this year compared with a year earlier, federal data show.