FHA's reserve fund hits 7-year low
Agency's cash running low; automatic bailout possible if loss continues

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.

Then, when the housing market swooned and prices fell, many borrowers who suddenly owed more than their homes were worth fell behind on their mortgages. Defaults spiked. About 24 percent of FHA loans were in default in 2007 and 20 percent in 2008, according to the agency. The agency's reserves kept tumbling.

FHA's reserves were $10.04 billion as of June 30, the lowest level in nearly a decade, according to agency data. Seven years ago, the fund had twice as much cash. It remains in the black only because it has accrued interest.

More recent data, due to be released in an audit this month, will show that the reserve fund fell below the federally mandated level as of Sept. 30 for the first time since the fund was set up, agency officials recently said. The excess money in that fund is no longer enough to cover 2 percent of FHA's outstanding loans, as required by law.

This year's audit was scheduled to be released on Wednesday but FHA abruptly delayed it, citing problems with financial-stress tests it had requested that went "above and beyond" what the audit typically entails. Agency officials declined to detail the nature of these problems.

"I don't know what 'above and beyond' economic scenario testing FHA asked [the auditing firm] to do, but it's pretty easy to envision how a 'truly stressful' scenario would wipe out" the FHA reserves, said Thomas Lawler, an economist and housing consultant, in his newsletter last week.

FHA Commissioner David H. Stevens has said that the audit results will appear dire because they offer a snapshot of the agency's financial standing at the depths of a severe recession without taking into account new loans the FHA will insure or the fact that many of these loans have been made to more creditworthy borrowers than the FHA typically caters to.

Stevens also noted that the FHA's financing fund now has about $20 billion, with the reserves as a back-up.

But he said agency officials were watching the housing market to see if they have to rethink their calculations. "Any worsening economic downturn, beyond what's anticipated by the audit, could have a greater adverse impact to capital and would be reason for caution," Stevens said in an interview.

Covering future losses

Each year, the FHA estimates how much money it will need in its financing fund to cover future losses on all of its outstanding loans and how much, if any, will be left over. Adding up those annual estimates since 1992 shows that the FHA had over time projected its revenue from premiums would exceed costs by $33.8 billion, and this surplus would move into the emergency reserve fund.

But almost exactly the opposite happened. The FHA had to shift a total of $34.4 billion out of the reserve fund and into the financing fund to cover losses. If not for the interest it collected over the years, the fund would be $647 million in the hole, instead of $10.04 billion in the black, according to the agency.

A few budget policy experts say the interest payments mask the true cost of the FHA's mortgage-guarantee program. But other experts say accruing interest is legitimate and that several federal trust funds operate that way, such as the Social Security and the highway trust funds. They collect taxes from consumers and interest on those taxes.

"These trust funds were intended to have a dedicated source of revenues over time, and therefore it make sense to count interest," said James Horney, director of federal fiscal policy at the Center on Budget and Policy Priorities. "It's not phony accounting. If the contributions you put into a trust fund are not earning interest, then you don't build up an adequate amount to cover future needs."

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