The New Changes to the FHA Loan Program

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Federal officials said last Wednesday that it will take awhile to smooth out the bumpy ride the credit and stock markets have been taking recently, but U.S. banks and the economy, overall, are in good shape.

In a prepared statement he delivered last Wednesday before the House Financial Services Committee, Treasury Undersecretary Robert Steel said an interagency group will study the role ratings agencies had in the recent market downturns, but "the economy was in strong condition going into the recent period of volatility, and while certain sectors like housing are undergoing a transition, overall economic fundamentals remain solid."

Rep. Barney Frank, D-Mass., who chairs the House panel, said many were surprised at how deeply problems in the subprime-mortgage market hurt other markets.

He asked whether regulation was needed to stave off more problems. "Sensible and intelligent regulation … worked better in the mortgage market than the lack of regulation," Frank said.

The committee's top Republican said lawmakers shouldn't act hastily to write new rules. "We should not rush out and change a market that is working and working well," said Rep. Spencer Bachus, R-Ala. He added many borrowers are able to get loans at better rates than they had in the past.

Highlighting the problem, the stock market fell sharply that same day after a report hinted at deepening troubles in the housing market. Compounding the problem, the Federal Reserve issued a survey suggesting the credit crisis did not appear to be affecting the economy outside the housing market. This report disappointed investors who hoped the Fed would cut the short-term interest rate when they meet later in September.

Compounding the problem, the National Association of Realtors reported an index tracking the signing of contracts for existing home sales dropped 12.2 percent in July, the lowest it’s hit in more than six years. The drop was attributed to homebuyers having a tough time getting financing.

The recent spike in interest rates banks and mortgage companies charge for jumbo home loans, those $417,000 and above, have dramatically hit areas where home prices are the highest. Pending home sales have dropped almost 21 percent in the West, where some of the highest prices in the country are found.

Many investors have stopped buying bonds backed by mortgages that do not conform to the standards followed by Fannie Mae and Freddie Mac. The two government-sponsored agencies buy home loan debt, and their bonds are considered second only to Treasury notes and bonds in terms of safety.

As the market rollercoaster continues, more are backing President George Bush’s recent proposal to expand the role of the Federal Housing Administration.

Bush wants to help homeowners who find themselves drowning in debt because the teaser rates of the attractive adjustable-rate mortgages they received in recent years may send 2 million or more into financial oblivion.

"It's not the government's job to bail out speculators, or those who made the decision to buy a home they knew they could never afford," Bush said in late August. "Yet there are many American homeowners who could get through this difficult time with a little flexibility from their lenders, or a little help from their government."

Bush proposes to expand the FHA, which guarantees loans for low-income borrowers. Under a program called FHA-Secure, it would refinance subprime loans in default. He said FHA-Secure is aimed at those homeowners who didn't fall behind on payments until their teaser rates expired.

Alex Pollock, a resident fellow at the American Enterprise Institute and former CEO of the Federal Home Loan Bank of Chicago, said, "The FHA used to be the dominant mortgage provider" for subprime borrowers, so it is the "obvious, sensible place" for lawmakers to try to stem the subprime fallout.

In the 1990s, FHA-backed loans accounted for about 12% of the market. But as subprime lenders pushed the envelope, the FHA's share has fallen to about 3%.

In the first quarter of 2007, the new foreclosure rate was 0.9% for FHA loans vs. 2.43% for subprime. The lower foreclosure rate suggests the FHA provides "more forbearance or mitigation" than sub-prime lenders, Pollock said.

The administration hasn't spelled out all the details of FHA-Secure, but Pollock believes the sensible way to limit risk to the government would be "to make sure that current lenders ... get a haircut."