FHA's reserve fund hits 7-year low

FHA chief David Stevens
FHA chief David Stevens
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By Dina ElBoghdady
Tuesday, November 10, 2009

The Federal Housing Administration, which has played a crucial role supporting American home buyers after the collapse of the mortgage market, has burned through a huge cash reserve in less than a decade and could soon wind up with what amounts to an automatic taxpayer bailout if the agency's fortunes don't improve, according to a review of FHA finances.

Senior FHA officials have assured Congress that the agency will not need a bailout, which would be politically sensitive for lawmakers to approve after the government has already spent hundreds of billions of dollars rescuing financial companies.

But the agency's complex funding mechanisms -- little understood in Washington, including on Capitol Hill -- do not require the FHA to turn to Congress if the agency cannot cover losses on its outstanding loans. The agency, which collects premiums from borrowers who take out FHA-insured mortgages, has been automatically drawing down on money it deposited with the Treasury Department when the FHA was flush with cash. Those funds have dwindled as the FHA's losses grew. If the losses continue unabated, the FHA would still receive money from Treasury.

"It is absolutely a myth that they would have to go to Congress for money," said Marvin Phaup, a former budget analyst at the Congressional Budget Office and now a budget expert at Pew Charitable Trusts. "The FHA has permanent authority to get money from the Treasury because it is backed by the full faith and credit of the federal government."

Below the threshold

The government is legally required to ensure that the balance in the FHA's emergency reserve fund does not drop below 2 percent of outstanding FHA loans. Over the past five years, starting during the years of the housing boom and continuing into the bust, FHA's reserves have tumbled and are now below that threshold, according to the agency.

Under a 1990 law, the FHA turns over to Treasury each year whatever excess money the agency expects to have left over after it pays losses on insured mortgages from what is known as the financing fund. The excess money is credited to the FHA's emergency reserve fund. In those years when the FHA underestimates its needs, it automatically gets an infusion from Treasury to make up the difference.

FHA officials say it is incorrect to consider these payments from Treasury as a taxpayer subsidy. The agency is in effect tapping money it previously parked with Treasury. But if losses on FHA-backed loans continue, the agency could find itself overdrawn, yet payments from Treasury would not stop. They would automatically continue, rescuing the agency with taxpayer money.

The FHA had been accumulating money ever since its emergency reserve fund was set up in 1992. The premiums collected by the agency from borrowers taking out FHA-backed loans regularly exceeded its liabilities. But the trend turned sour even as the housing market flourished. Leading up to the boom, private lenders started offering no-down payment and low-down payment mortgages to reasonably low-risk borrowers, effectively luring away some of the FHA's most reliable borrowers with less expensive loans.

"FHA could not compete as well for the best borrowers, and it was left with some of the riskier borrowers," said Mathew Scire, a director at the Government Accountability Office. Some of the loans left on FHA's books started going bad during the first half of this decade.

In each of the past seven years, the FHA has had to take money from its reserves to replenish the financing fund. In fiscal 2004, it transferred $7 billion in reserves -- a record high at the time -- to cover losses on loans from 1992 through 2003.

This recalculation prompted a study by the GAO, which attributed the reestimate to the FHA's financing of increasingly risky borrowers from 1995 onward as it lost ground to private lenders and loosened lending guidelines. Many of the losses were also attributed to a now-defunct program that encouraged defaults by allowing home sellers to help cover down payments for buyers.

As home prices fell, the downward trend continued. In fiscal 2009, when the agency recalculated its expected losses for loans made in previous years, it found it needed to transfer $10.3 billion from its reserves to its financing fund to cover losses, topping its previous record.

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