Today the FHA released its FY 2012 actuarial study and as documented by FHA Watch, the FHA’s financial condition continues to deteriorate.  This report should be cause for significant concern for Congress and taxpayers. As expected, the report shows that the FHA main single-family insurance program has a negative economic value of negative $13.5 billion. Even under generous accounting rules that no other financial entity gets to use, it is insolvent.

To make matters worse, this report is already obsolete and outlines a conservative estimate of the true losses incurred by the FHA. The projection of negative $13.5 billion is based on Moody’s July 2012 forecast projecting 10 Year Treasuries in CY Q3:12 to be over about 2.2% and climbing to 4.59% by 2014.^[1]  Today the 10-year is at 1.57%.  Under that same forecast, mortgage rates are projected to double to 6.58% by CY Q3:14.^[2]

The base case scenario ignores the Fed’s September QE 3 announcement.  FHA has once again ignored intervening events that dramatically change the base case findings in their annual report.  If the current low interest rate scenario were substituted, the FHAs FY 2012 is a negative $31 billion.^[3]  Yet, FHA chose cherry pick a piece of “good news”—the study projects that FHA will generate $11 billion in new economic value in FY 2013 and seize on it as evidence the 2012 deficit will be largely wiped out and all will be fine.  This ignores the of the real negative $31 billion hole in 2012.   No matter how bad things get today, FHA continually paints a rosy picture.   The SEC would be all over a public company that played by FHA’s rules.

Summing up:

1.    Each year the FHA gives Congress a report saying--don’t worry, next year will be better.  But each year it gets worse. 

2.    FHA’s negative $13.5 billion economic value for 2012 represents a deterioration of $23 billion from last year’s projection for FY 2012. 

3.    Just like last year’s report, this one materially misrepresents the facts, facts that no private company could choose to ignore.  It uses an interest rate forecast from July; made obsolete by made the Fed’s September quantitative easing announcement.  So instead of a negative $13.5 billion economic value, it is negative $31 billion. 

4.    The hole keeps getting bigger while FHA’s cash reserves dwindle.     

5.    The model FHA uses to calculate its actuarial soundness, while improved over earlier versions, continues to demonstrate that these projections are highly uncertain. The projection for FY 2018 had a total of $79 billion in plus and minus adjustments netting out to a negative $17 billion compared to last year’s projection.

These wide swings along with past negative revisions are cause for great concern.

Let’s focus on what we do know about the FHA’s fiscal condition:

1.    Under Generally Accepted Accounting Principles (GAAP) FHA has a current net worth today estimated at negative $26 billion, meaning it has a total capital shortfall today of $47 billion based on its 2% capital requirement.

2.    Its cash is dwindling fast and may be exhausted within the next 12-18 months. 

3.    One in six FHA loans is delinquent 30-days or more and this rate has been growing.

Bottom line: the longer it takes the FHA to return to a sound fiscal footing, the greater the risk to the taxpayers and further harming families and communities across America.

Immediate action should be taken to address FHA’s fiscal crisis:

Perform a safety and soundness review now: The House of Representatives, by a wide margin, passed an FHA reform bill in September that among other provisions required the GAO to have an independent third party conduct a safety and soundness review of FHA under GAAP applicable to the private sector.  This is critical, since it is likely that the FHA has a current net worth under GAAP in excess of negative $25 billion, meaning it has a total capital shortfall today of $45 billion.  We must know what the FHA’s true financial condition is.  It is unacceptable to state once again, not to worry, next year things will get better.   We cannot continue operating an agency with $1.1 trillion in obligations on rosy scenarios.

Apply an SEC-style disclosure standard to FHA now: The House passed bill also had a provision to hold HUD to the equivalent of an SEC disclosure standard—no public company could issue a report in November and ignore the Fed’s action in September.

The FHA must bring a credible plan to the Congress on how to deal with its insolvency.  To start, the FHA must reduce its tolerance for failure and return to its traditional mission.  It is financing failure for too many families, most of whom live in low- and moderate-income communities.  This is a disservice to low- and moderate-income families and communities it is its mission to serve.  The best way to do that is to reduce the risk layering combining (low FICO, low down payment, high debt ratios and/or slowly amortizing 30 year term) on its high risk mortgages.

Towards this end, the Secretary of HUD should immediately announce that to protect families and communities from abusive lending practices, it will not knowingly insure a loan for any family where the expected foreclosure rate, based on that family’s credit attributes, is 10 percent or more. 

Borrowers taking out high risk loans should be offered either a loan with a minimal down payment or a slowly amortizing 30 year term, but not both.  This only makes sense with home prices at their lowest in 10 years and interest rates at their lowest in generations.   

These three steps would put the FHA on the road to replacing irresponsible lending with responsible lending.

[1] Actuarial Review of the Federal Housing Administration Mutual Mortgage Insurance Fund Forward Loans for Fiscal Year 2012, November 5, 2012. Prepared for the U.S. Department of Housing and Urban Development. p.9.
[1] Ibid., p. 8.
[1] Ibid., p. 63.