Is There Any Doubt Now?

Is there any doubt that the federal government is now propping up nearly the entire housing market?

The New York Times reported here that the Federal Housing Administration, FHA, the government agency whose loan-insurance programs have essentially prevented the entire housing market from collapsing, is in severe trouble and has dwindling cash reserves. The agency has admitted that its cash reserves had dwindled to 0.53 of the total portfolio of loans held, far below the mandated 2 percent minimum. The FHA has acted as a backstop for the nation’s housing markets, ensuring that marginal buyers are approved for loans with minimal down payments.

The politicization of the goals and loan policies at FHA was nearly guaranteed following the collapse of the conventional housing market in 2007 and the federal takeover and subsequent bailout of Fannie Mae and Freddie Mac. Freddie and Fannie have been propped-up by the Federal Reserve for the last two years, which has purchased a significant percentage of the securitized mortgage products issued by the two agencies in the absence of conventional buyers. Now, FHA may require federal intervention to prevent its own collapse. With no plan for the eventual re-capitalization of Fannie or Freddie on the horizon, it is now virtually guaranteed that the federal government will continue to play the most important role in the nation’s housing markets for years to come.

What’s truly alarming, though, is FHA’s rather transparent efforts to conceal the extent of its problems. By lowering its loan underwriting criteria and extending loans to larger pools of risky credit borrowers, the FHA is hoping to reduce the overall percentage of currently delinquent loans relative to its total loans outstanding.

In effect, the FHA is extending more loans to marginally poorer credit risks, inflating the size of its overall loan portfolio, and then claiming victory, as the overall percentage of its delinquent loans declines relative to total loans. This may, though, ultimately become a pyrrhic victory of sorts if the housing market continues to deteriorate and foreclosures continue to accelerate. FHA is essentially betting that it can outrun its problems by increasing the size of its balance sheet.

These are the same bets made by speculators and other investors at the height of the national euphoria that engulfed this nation, and it was painfully obvious how this dynamic played out. Politicizing FHA and forcing it to play an even greater role in the housing markets is a recipe for disaster.

The nations leaders and housing “experts” continue to ignore the fact that the only remedy for the ills of the housing market is to ensure that greater numbers of people legitimately qualify to own homes, and only two methods will ensure this: either personal income increases or asset deflation in the housing stock must sufficiently reduce home values. In this time of severe recession, personal income is likely to remain relatively stagnant for years.

Lower home values, while accelerating the pain of those that viewed their homes as retirement portfolios, will ensure that greater numbers of families will ultimately qualify for loans. Attempting to re-inflate the housing bubble by lowering credit standards will simply ensure that another massive federal bailout will soon occur, this time at FHA. By sustaining the unsustainable, the federal government will prevent any real recovery in overall asset valuations and ensure that future economic growth will be tepid at best. Short term housing stimulus will prevent real growth and recovery in the long-term.

Asset valuations, especially the housing sector, should be allowed to fall to levels commensurate with income and sustainability. Absent this, it will be a painful decade, at best.