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Demoralized Mortgage Insurer an Overlooked Challenge in Crisis



With credit remaining tight and banks continuing to restrict lending, it’s been up to the government to keep the mortgage markets moving. And a major player these days is the Federal Housing Administration, a Depression-era insurer of mortgage loans specifically tapped to take on a much larger role as savior of the housing sector and rescuer of homeowners facing foreclosure.

But with the FHA’s share of the mortgage market expected to grow to nearly 50 percent, the agency finds itself facing the same dilemma as its parent, the Department of Housing and Urban Development. Both were shunted aside during the Bush Administration. Like HUD, the FHA doesn’t have enough staff or even up-to-date technology to handle its expanded role. It lowered its loan standards to compete with private lenders during the subprime boom, and problems with fraud continue to plague it, just as it backs more loans than ever.


Illustration by: Matt Mahurin

Even the president of the banking industry’s trade group warned Congress recently that the agency needs to stop predatory lenders from finding their way into FHA lending programs.

Even beyond that, the FHA must turn itself around and operate at its peak, after years of neglect. While the Obama administration tackles the stimulus plan and other urgent problems, government agencies like FHA and HUD, long relegated to the sidelines, are being called on to ramp themselves up and take on greatly expanded tasks. With the financial crisis so severe, the revitalization has to happen immediately – and there’s no Plan B. Getting these agencies back up to speed is an overlooked challenge facing the new White House regime.

Sheila Crowley, president of the National Low Income Housing Coalition, described that challenge as “extraordinary.”

“When you’ve been operating under a belief system that government is the problem and is not helpful, which has been the direction under the Bush Administration, people get demoralized and that makes it harder to get anything done,” she said. “HUD and the FHA have lost a lot of people and they’ve been neglected over the past eight years. There just aren’t enough people left to do everything the government is asking them to do. It’s a pretty hefty assignment to turn them around.”

The view from the private sector isn’t any rosier. “The FHA’s role has been so small until recently that no one’s paid attention to them,” said Robert Eisenbeis, chief monetary economist at Cumberland Advisors money management firm and former director of research at the Federal Reserve Bank of Atlanta. “They’ve been seen as sort of the group that licks the bottom of the bowl. So, no, there’s not a lot of confidence that they can suddenly run the show.”

FHA’s troubles were highlighted recently by HUD Assistant Inspector General James Heist, who told a House Financial Services Committee at a hearing earlier this month that “we have had, and continue to have, concerns regarding FHA’s systems and infrastructure to adequately perform its current requirements… FHA may not be able to handle its expanded workload or new programs that require the agency to take on riskier loans than it has had in its portfolio.”

An audit of FHA’s roster of approved appraisers found 3,480 appraisers with expired licenses and 199 with state sanctions for abuses, Heist said. The agency has just one person assigned to work with the states in complying with new national licensing requirements for mortgage brokers and loan officers. Its computers and software date back to the 1970s and 1980s. Despite the availability of commercial, off-the-shelf software, the agency’s process of approving lenders for its programs remains a largely manual task.

Overall, the FHA needs to increase its staff, increase training for its staff, increase the the oversight of its appraisals and underwriting, and improve the way it vets lenders taking part in its programs, Heist said. The number of FHA lenders approved for its programs jumped by 330 percent over the last year, as credit tightened. But the agency still has problems with continuing to allow lenders with past predatory abuses into its programs, he said.

The “integrity and reliability” of the newer lenders is “unproven,” Heist said, and “in light of the aggressive recent history of this (subprime lending) industry, may pose a risk to the program.”

Howard Glaser, a mortgage industry consultant and former Clinton Administration HUD official, was more blunt. While the agency’s share of the mortgage market will soon approach 50 percent, up from just 3 percent 18 months ago, Glaser said, “the FHA does not have the capacity to handle that kind of volume.” He described the FHA in the near future as akin to a $2 trillion insurance company, without any risk controls.

“They’re the only financial corporation of any note in America that lacks a chief risk officer and a chief credit officer,” he said. “It puts probably many billions of taxpayer dollars at risk.”

That risk also came to light when a Business Week investigation found the same subprime lenders that contributed to the mortgage crisis were finding their way into FHA-backed lending programs, with the agency failing to identify and disqualify them. But the track records of those lenders were easily available – in FHA’s own database, noted Brian Chappelle, a former FHA official and industry consultant.

“There’s no question the FHA needs resources, and that there’s been a loss of career staff and institutional knowledge. That’s a given,” Chappelle said. What’s unknown, he added, is whether the FHA can change its culture to handle its expanded role. “If they have the will, they can do it,” he said.

An HUD spokesman said no one was immediately available for comment. HUD said in a written statement to the House Financial Services Committee that it was closely monitoring loan defaults.

FHA’s expanded role in insuring mortgages is a dramatic contrast to its past.

The agency was created as a New Deal program in the 1930s to help struggling Americans buy homes. In the 1960s, it was brought under HUD, with the goal of increasing home ownership by insuring loans made to underserved populations and borrowers with modest incomes. In the last 15 years, its goal has been to reach mostly urban communities that were subject to redlining, said David Berenbaum, executive vice president of the National Community Reinvestment Coalition.

But as the private sector began about a decade ago to move into the subprime market, FHA’s loan share declined. By the height of the subprime boom, in 2006, FHA’s share of the mortgage market had fallen to 2 percent, according to the agency.

At the direction of former HUD Secretary Alphonso Jackson, and with the support of the White House, the FHA began loosening some of its lending standards to compete with the private market, Berenbaum said. Jackson issued a rule allowing more self-policing for lenders in FHA programs, and he supported raising loan limits. Jackson also maintained that HUD had plenty of resources to deal with the foreclosure crisis, and insisted it wouldn’t be that severe, Berenbaum noted. During his tenure, FHA foreclosures and defaults reached record levels.

Jackson resigned last April over a criminal investigation into charges he steered HUD contracts to business associates and friends. HUD Inspector General Kenneth Donohue in 2007 criticized both Jackson and Brian Montgomery, the current FHA commissioner, for pushing to change FHA lending standards.

Montgomery, who has been asked to remain in his position until a new commissioner is chosen, is a longtime Bush loyalist, a former director of advance for the Bush White House, and an advance man for former president George H.W. Bush. He had no prior housing experience. Montgomery’s predecessor, John Weicher, a conservative economist and now a senior fellow at the Hudson Institute, headed the FHA.

Montgomery, however, surprised critics and won praise from both Democrats and Republicans for being an advocate for his agency and for trying to make it more efficient. But he wasn’t able to do enough, Chappelle said. During Weicher’s tenure, the agency “withered,” he said.

As the mortgage crisis worsened during the last year, Congress and the Bush Administration increasingly turned to the FHA to keep the mortgage market going, encouraging borrowers to refinance into stable, government-backed loans, getting lenders to participate and making more changes to increase the number of eligible borrowers. FHA-backed loans generally have lower downpayment and credit score requirements.

The FHA is funded by mortgage insurance premiums paid by borrowers, which go into a fund to cover losses on mortgages the agency insures. Taxpayers would only have to kick in money if the fund fell too low. But Heist warned the fund has been shrinking recently, down some 40 percent over the last year. The $12.9 billion now in the fund comprises 3 percent of mortgages insured by the FHA, a decline from 6.4 percent last year, and just above the 2 percent ratio required by law, Heist said. About 6.5 percent of FHA-backed loans are in default, he said.

Since it was created in 1934, the FHA has never had to ask for government help to cover its losses.

With its market share rising, the government wants the FHA to keep backing new loans and do a large volume of refinancings as well – something that will require a significant amount of new equipment, resources and staff, Berenbaum said. He and other housing advocates, like Crowley, are counting on the Obama administration to come though with those resources and to rebuild the agency.

As Chappelle pointed out, the agency has come full circle, back to its Depression-era roots as the insurer of home loans in difficult times. The dilemma ahead is whether its recent history will keep it from fulfilling that mission.

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