What’s Behind Rising FHA Defaults?

Note from The Tim: Jillayne Schlicke has been a valued member of the Seattle Bubble community for quite some time, and I’m happy to welcome her as a guest poster. Jillayne has many years experience in the lending industry and offers some great insights. She currently provides continuing education for real estate professionals through her company CE Forward.

I’d like to thank The Tim for inviting me to create occasional guest posts for Seattle Bubble readers. SB’s bloggers and commenters have taught me how to critically analyze local real estate statistics. SB was a safe place I could go on a Friday night when my kids were elsewhere and I was craving an understanding of what was happening during the 2007-08 meltdown. I am honored to give back to the SB community.

The rising default rate on FHA loans is concerning but I’m not terribly surprised. It’s really no secret that the government is using Fannie, Freddie and FHA to help keep the banks afloat by allowing zombie banks to pawn off their toxic crap to the agencies. Ultimately the taxpayer is paying the price as we see Fannie and Freddie continuing to run a red balance sheet and FHA headed down the same path.

FHA originations were all but dead during the real estate bubble because so many LOs favored subprime lending where underwriting guidelines were non-existent. But long ago, in a land far, far away, when we were rocking out to Duran Duran, Echo and the Bunnyman, and Joy Division, I was processing FHA loans for a mortgage banker in Seattle. When rates came down to a low of 13% I had about 100 files in process. I was trained to pre-underwrite my files so underwriting recruited me and I became a young underwriter at age 23, just old enough to go drinking after work with the crew. I’ll never forget Barbie Owens who had the entire FHA underwriting manual embedded into her brain Matrix-style (I know Jujitsu!) She could recite entire paragraphs from the manual verbatim. Imagine 20 female underwriters, all of us smoked, and none of the windows opened. That was mortgage banking in the 80s. But I digress.

Back in the 1980s, underwriting was serious business. We were treated like gods by the loan originators who worked in fear of us declining their deal. Only David Korch knew how to play it. He brought us ice cream bars on hot, sunny days. New underwriters were given bunny files; easy conventional refinances, to cut our teeth. Then we were sent to FHA training. FHA had a field office in Seattle with real humans who would actually answer the phone and our questions. At least once a year a representative from FHA would take new underwriters through a six week FHA underwriting course called Direct Endorsement 101. After we finished we could underwrite FHA credit only (on all FHA loans the appraisal goes through a separate underwriting process) as long as a senior FHA underwriter signed our files.

If an FHA loan went into default, it was presented as a case study in meetings so that all of us could learn from our mistakes. If an FHA underwriter had too many defaults against her identifying number, she was put on probation.

This all changed during the subprime days when FHA’s business went down to literally nothing. Today, FHA allows the FHA-approved lenders to appoint and train their own underwriters! Does anyone see the problem with that policy?

Let’s revisit early 2008. Wholesale lenders are dropping like flies, and six figure income mortgage brokers are sweating bullets trying to figure out how to make their next boat, BMW, second home, first home, and condo-in-Hawaii payment month after month. They see the writing on the wall and the future, as far as they could see, was FHA. Thousands of mortgage brokers rushed to become approved to originate FHA loans and hundreds of wholesale lenders and banks had to quick beef up their underwriting departments to handle the onslaught of FHA loans being hurriedly thrown at them.

Many of those underwriters only knew subprime loans and had never seen an FHA file, never read the FHA Single Family Mortgage Insurance Manual for 203b loans and suddenly lenders were making folks FHA underwriters overnight.

And now we’re wondering why default rates are so high.

FHA doesn’t make subprime loans. They will allow loans to people with less than perfect credit but this is definitely not subprime territory.

We have three main problems leading to this dramatic rise in FHA defaults:

  1. Pressure from government to use FHA for purposes of taking toxic loans off the bank’s balance sheets;
  2. Lack of education, training, and mentoring of new underwriters during the recent, dramatic rise in FHA originations; and,
  3. Lack of a large enough down payment from the homeowner to insure against falling home prices.

Negative equity combined with job loss, business failure, or other financial distress means higher FHA defaults are in our future as long as home values continue to drop, we allow banks to put underwriters into service with no training, and we let the politicians use FHA as a toxic waste dump.


About Jillayne Schlicke

Jillayne has many years experience in the lending industry and has a unique inside perspective on real estate. She currently provides continuing education for real estate professionals through her company CE Forward.

60 comments:

  1. 1
    ray pepper says:

    “as long as home values continue to drop”…………….The key phrase Jillayne. FHA and all other loan’s will continue to default in record numbers for many years. The bandaides will never stop arterial wounds. The trendline down/sideways market for many years ahead will cause short sale after short sale and foreclosure after foreclosure.

    Until Buying makes sense compared to renting our market will continue to trend downward and the defaults will continue relentlessly. This has been pointed out by many Bubbleheads and I like to pound the table when I say “PEOPLE ARE NOT STUPID.” Family 1st always!

    What will change this? Buying GEMS! Short sales and Foreclosures. People will get many great deals over this decade. We never let a home go that has equity in it right? NEVER!

    Its so simple to see how this will rectify itself but it will take YEARS!

  2. 2
    patient says:

    Thanks Jillayne for a very informative post. I would guess that the main reasons for defaults on loans are:

    – Adjustable payments due to teaser rates from loan options like ARMs, IO etc. that ends up with higher payments than the borrower can handle.
    – Loss of income ( divorce, unemployment, medical bills etc ) making the borrower unable to make payments.
    – Strategic walkaways when the payments makes no sense compared to what current payments would be if a similar home was purchased to current prices.
    – Relocation with inability to sell the home and cover the loan value.

    All of these in theory should not lead to any loss to the lender as long as prices are going up and the home can be sold to a higher price than the loan value thus the same should be true for 2 of your three bullets on FHA problems. Isn’t the real and only problem that FHA is granting loans with a to low downpayment? Historically going back a couple of decades it seems that common sense dictated a 20% downpayment to insure against default losses when the market is stable and/or are going up…now we are in a declining market and FHA is making loans to about 80% of all first time home buyers with downpayments as low as 3.5%. Isn’t that the core of the problem?

  3. 3
    Kary L. Krismer says:

    By patient @ 2:

    Historically going back a couple of decades it seems that common sense dictated a 20% downpayment to insure against default losses . . ..

    Why do people keep saying that? That wasn’t even true 30 years ago. The only thing significant about 20% is that’s where some form of mortgage insurance is required. PMI existed at least 30 years ago.

    What changed was getting around mortgage insurance by doing an 80/20 (or similar) package. I’m not exactly sure when that started. I’ve always thought that the PMI and FHA folks were harmed by that because they didn’t have the income stream necessary to take on the volume of new business when sub-prime went away. But maybe that was actually a blessing for them, because they also didn’t have the losses. Those fell on those who that that by buying a 20 from an 80/20 that they were buying secured debt.

  4. 4
    Kary L. Krismer says:

    Jillayne, out of curiosity, during the “old” days of FHA underwriting, did the underwriters even look at a credit score (as opposed to a credit report)?

  5. 5
    patient says:

    RE: Kary L. Krismer @ 3 – Kary, if you need insurance other than the downpayments it’s pretty much the same thing. Common sense tells you that with less than 20% down you run a risk of not being covered hence you need insurance. Two sides of the same coin.

  6. 6
    Kary L. Krismer says:

    RE: patient @ 5 – But that doesn’t mean the loan shouldn’t be made, or even that it’s necessarily more risky. Some people actually don’t want to have to put extra funds into their house, and would rather pay an extra 1/4% more on their loan (what PMI used to cost).

  7. 7
    patient says:

    RE: Kary L. Krismer @ 6 – From a business point as an insurer you could be right in an appreciating market, in a declining market it seems like suicide ( I’m not sure but I don’t think PMIs has been doing stellar lately ). From a buyers point of view, if you can’t pay for 20% of your purchase (any purchase ) you probably shouldn’t buy imo. It also makes little sense that we keep inventing ways of blowing home prices higher and higher. A strict 20% down policy would cause an initial re-pricing downwards but we would be left with a much more stable and healthy market going forward. It would be better for the country if we stop sucking away so much of our GDP into housing and spent more on for example education for ourselves and our kids. Just look at what housing is doing to the economy now, let’s try to fix the causes instead of treating the symptoms with things like FHA 3.5% down.

  8. 8
    Tim says:

    I was listening to the radio (710AM) the other day and a company was advertising FHA Streamlines. The ad basically amounted to: No income check, no asset check, no appraisal…etc. You might as well just say it is the new subprime.

    Coming Jan 1, 2010 the FHA Streamline is going to get tougher and the mortgage companies are going to have to change their “tone” of ads pushing FHA products (currently marketed as if they were back to the good old days). I sense a lot of the culture in pushing FHA as follows: FHA high LTV’s = higher compensation; who cares if the loan goes bad.

    New changes to FHA Streamline this January 2010:
    1) Appraisal “advised” (whatever that is supposed to mean).
    2) 97.75% Max LTV
    3) Income verified
    4) Assets verified
    5) Higher credit scores, etc..

    And the company making the ad mentioned: …”licensed by the Washington State Department of Corporations.” Anyone at DFI listening?

  9. 9
    The Tim says:

    Another great article about FHA this morning from Denninger: CORRUPTION: Government Housing Programs

    22.9% of all FHA loans are either delinquent or in foreclosure.

    30 days are up, 60 days are up, 90+ days are up, default+foreclosure is up and 60+ including foreclosures are of course up.

    …$50,000 annual income, married, 2 dependents in San Francisco, no declared reserves, one car with a $300 payment monthly, approximately $5,000 in credit card debt at a 5% minimum payment and $100 in additional monthly debt payments (e.g. student loans, etc.)

    A lower-income person in California.

    Ginnie claims that this person can spend 36% of their gross income on housing, or the front-end ratio (they also include $342 monthly for other housing-related costs, presumably homeowners insurance and utilities) and 49% of gross income on housing and all other mandatory debt service, or a 49% DTI.

    This is preposterous. Such a loan will leave this couple with $1800 in monthly income – pretax!

  10. 10
    patient says:

    RE: Tim @ 8 – Wow, that is a scary development but not surprising. Regarding the new guidelines do you happen to know how the required downpayment is set? Does it have anything to do with the home price trend where the home is to be purchased?

  11. 11
    AMS says:

    If values had continue to rise at 10%+ per year, then FHA would not have these problems. Lax underwriting standards might have lead to housing price inflation, which only lowered the FHA losses during that time.

    I know a retired guy who put what I will call “putting his eggs all in one basket.” He personally underwrote mortgages, and he felt it was a sure way to get an above average return. The theory was simple: Underwrite housing, and if the debt is not repaid, simply foreclose. In general there would be close to enough equity to cover the foreclosure costs on an undiscounted basis, so the losses would contained and relatively low, or so the theory went.

    After many years of shunning me about the risk, recently he called up asking me for advice. I knew things were bad. He’s taking heavy losses, and he wants to sell at today’s prices, but he cannot push the foreclosure process along fast enough to do so. Yes, he did have the mentality that housing prices only go up.

    If you want to make sure there is never a black swan to be found, then you must avoid uncharted grounds, of which the future is full.

    Looking at the macro level, there seems to be very few options to prop housing prices back up: Change the mass psychology so as to put home prices back on a solid foundation. (Ultimately all solutions involve some use of this.)

    1. Inflate the dollar. (This is a cost-push argument–if housing costs too much, then the dollar isn’t worth as much, at least within the bounds of the US. Inflating the dollar gets to be problematic when looking at international trade.)
    2. Attract more investors into the market. The problem with this is that eventually it will collapse, but the collapse could be much slower. For example, if housing prices remained constant for ten years, then that would be ten lost years on an investment, or less with some inflation. In this case, however, the loss is so gradual that it is spread out so very few notice the impact. If nothing else, the biggest risk is the transactional costs. (Yes, I understand that there is a problem with the condition of the various homes, and this does not reflect that some areas will increase in desirability, and other problems.)

    Right now what we have is both falling prices and falling volume, as measured by total dollars transacted. The basic economic theory is that there is a greater quantity demanded when prices are lower. In this market lower prices have not increased the volume of total dollars transacted. Certainly I do recognize that total dollars transacted is a function of both the number of homes sold and the average price. If one or the other goes to zero, then there will be no dollars transacted. It should also be clear that if all homes are over-priced, then the the number of homes sold will go to zero. With some nice assumptions, it should be clear that there is a single maximization point between a price of zero and a clearly over-priced market. Yet we have falling volume as prices drop…

  12. 12
    Jillayne says:

    @patient “now we are in a declining market and FHA is making loans to about 80% of all first time home buyers with downpayments as low as 3.5%. Isn’t that the core of the problem?”

    Declining values is a huge problem when a homebuyer or refinancing homeowner is going there at almost 100% LTV. It’s also important to pan out and see it from a wider angle. The defaults happening today were because of underwriting decisions made last year. Let’s pretend that values stabilized in 08 and started to rise in 09. I believe we would still have high FHA defaults due to poor underwriting as well as the minor problem of the government encouraging the banks to refi problem loans into FHA loans in 08 and 09.

    It’s like tasting a delicious chocolate cake and saying the reason it’s delicious is the chocolate. Well the quality of the chocolate is a big part of the taste but there are other ingredients that enhance the flavor. Sorry for using such a girlie metaphor.

    We could think of it like this: If collapsing home values are the only reason FHA defaults are rising then that would mean in a rising home value market we would have zero defaults and we know the latter is not true.

  13. 13
    patient says:

    RE: Jillayne @ 12 – I fully agree Jillayne what I’m saying is that the default is not a problem for FHA or any lender in itself. It is the mix of default and the LTV being above 100% at time of default that amounts to losses. So yes, defaults would happen at a similar rate with poor underwriting and guidelines but if they don’t amount to a loss it’s not really a problem that will punish FHA and potentially the tax payer. I.e if the home can be sold to voer the full loan amount it’s a default but not much of a problem.

  14. 14
    Jillayne says:

    Hi Kary,

    Yes, private mtg insurance has been around since at least 1957 so we’re talking over 50 years. I believe the 80/20 loans went mainstream right around 1999, 2000 when it was considered smart to go 80/20 to avoid PMI!

  15. 15
    Jillayne says:

    Hi Kary,

    Back in the 1980s we did not look at a person’s credit score. We looked at their entire credit history, however the scoring system was not a factor.

    Everyone received the same interest rate on their FHA or Conventional loan whether or not their credit score was 800 or 500.

  16. 16
    AMS says:

    RE: Jillayne @ 12

    “If collapsing home values are the only reason FHA defaults are rising then that would mean in a rising home value market we would have zero defaults and we know the latter is not true.”

    There will always be situations here and there that cause foreclosures, but that’s not to say that the lender takes a loss on the foreclosure. There will be a certain level of those borrowers who never make a payment.

    There are some situations where a foreclosure isn’t so bad. For example, a death can be a situation that a foreclosure is a good solution for the lender. Natural disasters can cause situations where foreclosures will be required. While there will always be some background noise, but the losses to the FHA fund, as well as owners in general, are minimized during a period of rising prices.

    I hope it is obvious that falling market values only adds to the lender’s losses, no matter what the reason for foreclosure. Also I hope it is obvious that falling prices only increases the number of foreclosures. In other words, we start with some background noise number in a rising home price market, and then we add for falling market values.

  17. 17
    Jillayne says:

    Tim,

    Regarding FHA Streamlines, this is only for refinancing one FHA loan into another FHA loan.

    Once again, FHA is slow on the uptick to change these guidelines. Why not start NOW?

    HOWEVER, recall that although FHA sets minimum guidelines, banks and lenders can be tougher than FHA’s underwriting guidelines.

    Here’s a great story from 2008. Mortgage Loan Originator student says he’s been selling FHA ARMs like mad because he can qualify people at the teaser rate. I ask him to analyze that decision from an ethical standpoint knowing what we know now about ARMs. He says, “no problem, I can just refinance them to a fixed rate loan using an FHA streamline.” I asked, “What if the underwriting guidelines change?” He says, “Well I can be expected to see that far out into the future.”

    This was spring of 2008.

  18. 18
    BuyerSan says:

    The other day I saw this message from someone pitching for a homebuyer education class:
    ————————————————————————
    I started the home buying process by taking a free Homebuyer Education class sponsored by the WA State Housing Finance Commission 1st. They break the class up into two parts. The 1st part talks about how to qualify for a loan, the different types of loans that are available, what they look for in credit scores, and differences between getting a loan from a bank, mortgage broker, or mortgage banker. What is awesome is they give you a broad perspective so you can make decision that are best for you. The 2nd part talks about the home buying process and what to expect from a realtor. They also talked about some of the special programs that are available that you might qualify for.

    The key takeaway I got from the class was that if you have a credit score of 620 or above then there is a good chance that there is a loan out there for you, and if your credit score isn’t quite there, they talk about the steps you can take to repair it. I also decided that going with a Mortgage Banker actually provided me with a lot more available options for loans. I was also able to decide on the right type of loan for me which was a FHA Loan.

    In the end I not only was able to get an FHA Loan, but I also qualified for the House Key State Bond 1st Mortgage Loan that helped me come up with the 3.5% down payment that is required. So my expenses at closing were less than $2,000.

    Before I took this class I always felt like buying a home was out of my reach. This class helped me make educated decision and understand my different options, and now I have my 1st home and a mortgage that I feel is right for me.
    ————————————————

    Really? No comment.

  19. 19
    Mike2 says:

    Excellent post Jillayne. I do wonder about this statement though:

    “FHA doesn’t make subprime loans. They will allow loans to people with less than perfect credit but this is definitely not subprime territory. ”

    While some of the FHA loans might qualify as “Prime” due to the credit, capacaity, collateral, etc of the borrower, many do not. If they aren’t prime, what are they if not subprime?

    How would you categorize FHA loans to borrowers with middling credit scores, high debt to income ratios and little in the way of assets?

  20. 20
    Jillayne says:

    The_Tim and Patient:

    Standard FHA ratios are: 31/43.

    For those who need the long answer:

    First ratio:

    principal, interest, taxes, insurance (PITI) divided by total gross monthly income

    Second ratio:

    PITI plus all other monthly debt divided by gross monthly income.

    Patient,

    Downpayment for a purchase money loan is 3.5%

    Recall that all of the downpayment can be in the form of a gift from a relative.

  21. 21
    Jillayne says:

    AMS,

    I like your analysis in comment 11.

    Question. What happens when we experience both numbers 1 and 2?

  22. 22
    Jillayne says:

    Hi Mike2 “How would you categorize FHA loans to borrowers with middling credit scores, high debt to income ratios and little in the way of assets?”

    Well, this sounds like a typical FHA borrower with one change: FHA doesn’t do high debt to income ratio loans.

    Ratios should be right around 31/43.

  23. 23
    Jillayne says:

    Hi AMS, “I hope it is obvious that falling market values only adds to the lender’s losses, no matter what the reason for foreclosure. Also I hope it is obvious that falling prices only increases the number of foreclosures.”

    Yes. We are stuck in a feedback loop and it’s going to take quite a while to reverse the direction. I’m with Ray all the way back at comment 1. I believe home values will slow continue to decline for many years, unless something like what AMS is describing happens and we end up inflating our way out of it.

  24. 24
    Kary L. Krismer says:

    By Jillayne @ 15:

    Hi Kary,

    Back in the 1980s we did not look at a person’s credit score. We looked at their entire credit history, however the scoring system was not a factor..

    Thank you for the response. As I’ve said before, I think that’s what they need to get back to (real underwriting). Credit scores are lousy tools for determining mortgage qualifications.

  25. 25
    AMS says:

    RE: Jillayne @ 20

    Inflation always hurts those with cash savings, and generally helps those with hard assets.
    Investors generally look for above-average returns, on a risk-adjusted basis, no matter what the inflation rate is.

    If a person knew we were going to experience high levels of inflation, then he would want to take leveraged positions in housing (or some other physical asset). The problem is that if the lenders expect high inflation, then there will be a premium charged, and thus the attractiveness of housing is tempered by the inflation premium.

    If we independently inflate the dollar, then all debt goes away, if the inflation is sufficient. But all savings also goes away, including the value debentures.

    It is tough to separate inflation from investment in physical assets.

    It should be noted, however, that during a period of deflation that a person seeks to be paid back later rather than sooner.

    (There are other good investments during a period of high inflation.)

  26. 26
    Jillayne says:

    AMS,

    After some more deflation, do you think this is what they will decide to do: Inflate our way out of the housing mess?

  27. 27
    patient says:

    RE: AMS @ 24 – I would be very surprised if high inflation will happen. We have a new police with a very powerful stick to punish us with if we let it happen. China and the the debt they currently hold and are expected to continue to hold and increase to support all the bailouts. If they sense that the US is deliberately encouraging inflation they will probably threat the dump their treasuries and stop buying more and that will make our current problems look like nothing.

  28. 28
    Ross says:

    RE: patient @ 27 – China dumping US debt could hurt the US, but it would also hurt China. It’s kind of like trashing your home because market values are going down.

  29. 29
    alex says:

    Some things simply can’t go unspoken:
    1) The band name is “Echo and the Bunnymen” (plural)
    2) In “The Matrix”, after his first series of brain downloads, Neo said “I know kung fu!” – not Jiujitsu.

  30. 30
    patient says:

    RE: Ross @ 28 – That’s true and is probably the reason why they haven;t done it already but if they see that there investment will vaporize due to high inflation I think it’s pretty safe to assume that they rather put the money somewhere else like oil, gold, euro. We are talking about inflating away our debt here, do you really think the people holding this debt will let that happen?

  31. 31
    Jillayne says:

    Thanks alex. I stand corrected. I thought for sure it was “I know jujitsu.”

  32. 32
    alex says:

    RE: Jillayne @ 31

    :) well, thank YOU for the great insights in the article – and for playing along with the picky geek in me.

  33. 33
    Kary L. Krismer says:

    I just received an email linking to what the FHA is doing to reduce its risk on condos.

    http://www.realtytrac.com/ContentManagement/RealtyTracLibrary.aspx?channelid=8&ItemID=6783

    The noise issues are sort of crazy. No approval if within 1000 feet of a freeway, so if you have a view condo overlooking I-5, no more FHA. No approval if within 5 miles of a military airport. You would think they would use different lengths for beside the airport as opposed to under the approach path.

    The big thing though is no more spot approval. That will really hurt some.

  34. 34
    softwarengineer says:

    I’m Hearing You Bloggers

    And I agree with your general intents.

    Affordability is being swept under the rug the last 5-10 years because otherwise, there’d be no housing market at today’s insane prices.

    The answer is what they did during the 1990s housing bubble, no loans to exceed 30% of real net pay after car, college, credit card, etc loans are removed from net pay. Its that simple. 20% down minimums too, especially since price degradation appears to have no end.

  35. 35
    AMS says:

    RE: Jillayne @ 25

    First let’s separate deflation, which is the rising value of the dollar, from falling home prices. Home price might fall yet the dollar could be experiencing inflation. I do not think this is the case.

    I have not found a single historic example of wide-spread falling home prices and inflation at the same time.

    There is another problem that I didn’t mention during a period of deflation, and that is the desired point of consumption. Most people seek a known level of inflation to keep an incentive to buy today. During a period of deflation there is an incentive to continue to put off buying, as prices just keep going down. As a consumption based society that we are, we need a certain level of inflation. Also known inflation does not adversely impact cash holders, as they know what to expect. On the extreme, Weimar style inflation leads to and might be the cause of the collapse of society.

    The problem that I cannot resolve is how to return to inflation, yet not high levels of inflation, while balancing employment (cost-push/demand-pull could both be a problem).

    With the high levels of national debt, I think there will be a period of high inflation, but like the housing collapse, when is the bigger question.

  36. 36
    AMS says:

    RE: patient @ 27

    If China uses too much economic force, then that could inflate the dollar even more.

    I can hear the US saying, “Here, we will pay you back with these dollars that are not worth as much…” Of course we will fire up the printing presses to pay back our debt (monetary inflation).

    I do not think we will experience hyperinflation, and let me repeat: I cannot find a good example of a major economy that has had reductions in home values while the currency experienced inflation. In my opinion, as long as we continue this trend, there is no threat of inflation.

    For the record, unless stated otherwise I measure inflation using the purchasing power of a unit of currency method. Others use measures such as the supply of money. If the supply of dollars grows while the goods and population stays constant, then the dollar value of the goods erodes, and thus the price of goods grows. Ultimately there is no single good way to measure inflation, as every method has some weakness.

    This is a good point to talk about trade.

    For some reason many consider a “trade imbalance” to be bad. We send China green sheets of paper, and they send boat loads of goods.

    Yesterday I went to Starbucks and said to the friendly Barista that I have noticed that we have been involved in a trade imbalance. It seems that every time I come to Starbucks I walk in with cash and walk out with coffee. This is not very balanced. To balance the deficit, I should walk in with coffee and out with cash. For some reason a “trade deficit” with my local Starbucks is just fine, but a “trade deficit” with China is a bad thing.

  37. 37
    patient says:

    “If China uses too much economic force, then that could inflate the dollar even more.”
    Exactly and therein lies the real danger. If the world gets flooded with dollars in the form of US debt (dumped by China) that noone wants we get extreme dollar weakness, i.e the dollar is not worth the paper it’s written on or if you want hyper inflation. The FED is aware of this and will not let it happen, forget a strategy to inflate ourselves out of this, it will not be allowed. To counter deflation with low interest rates and money supply is one thing, to create high inflation something totally different. It’s universially known and proven to destroy economies and will destroy our credibility as a responsible nation seeking stability. Not going to happen.

  38. 38
    patient says:

    RE: AMS @ 36 – AMS if you just consume and don’t produce you will endup in trouble. If the people at Starbucks did not consume any goods or services in the US and Starbucks was the major trading partner with the US you would drain the country of money without getting anything lasting in return. Not good in the long run. So you don’t need to bring them coffe but they need to buy whatever you offer from your line of work to create balance.

  39. 39
    AMS says:

    RE: patient @ 38
    RE: patient @ 37

    This is in reply to both posts, combined.

    On the one hand you have the claim that we will not inflate our way out.

    On the other hand you have the claim that, “if you just consume and don’t produce you will endup in trouble.”

    It is no secret that manufacturing in the US has gone down. I have not checked the farming numbers recently, but I doubt that’s gone up enough to make a significant impact.

    So how do we keep inflation low when we do not have sufficient production?

  40. 40
    patient says:

    RE: AMS @ 39

    “So how do we keep inflation low when we do not have sufficient production?”

    I’m not sure I said that we didn’t have sufficient production. We have a trade imbalance with China. I’m also not sure how that in itself will lead to inflation? Can you expand on that train of thought? Perhaps move the answer to the open thread since this is an FHA thread that The Tim gracefully have allowed some expansion on but it’s getting rather polluted from the core of the thread.

  41. 41
    AMS says:

    RE: patient @ 40

    Conversation Continued.

    See Reply in Open Thread.

  42. 42
    one eyed man says:

    RE: patient @ 30

    I would disagree with the “haven’t done it” statement when referring to inflating away part of our debt to the Chinese. It’s true that the Fed hadn’t bought long term treasuries in years up until last March. But since the Fed announced that it would buy up to 300 billion in long term treasuries last March, the Dollar Index has dropped from about 88 to it’s current level of about 76. Meanwhile, China continues to buy short and medium term treasuries along with all the other investments they make with what was once our money.

    Unless the dollar index rises, It’s too late for the Chinese to avoid losing that 14% on their current portfolio of dollar denominated assets because Ben already sent it swirling down the drain. And you thought Ben was’t all that sharp. Arguably, the Chinese have already taken most of the inflation hit on their present and perhaps their future dollar denominated investments in which case, helicopter Ben would be more appropriately referred to as “quick draw Bernanke.” The gun fight was over before the Chinese got their gun out of their holster. Of course this analysis assumes that the decrease in the dollar index is to a large degree a market discount for predicted inflation in the dollar and that the dollar index won’t quickly reverse. You’re certainly free to debate those assumption. But I think they have a certain amount of merit.

    http://topnews.us/content/24517-federal-reserve-intends-buying-300-billion-worth-long-term-treasury

    http://www.traderslog.com/stock-charts.htm?page=chart&sym=DX*1&data=W

    We might still end up with deflation in the future, but unless you consider bringing the CPI increase down to a low positive number, or slowing the growth rate of the money supply to be deflation, we haven’t had much, if any, deflation in the general economy yet. And before you tell me that the CPI was “down” in the last 12 months, take a look at the numbers after eliminating the huge decrease in energy prices. According to the BLS August press release, not only did the CPI go up month over month:

    “The index for all items less food and energy increased 1.4 percent over the last 12 months, the smallest 12-month increase in the index since February 2004.”

    So what’s this got to do with FHA? The cost to taxpayers to fund losses by FHA is just another small piece of the insurance premium the taxpayer will pay to insure against the risk that the financial sector might implode and the economy might collapse as inflated real estate prices slowly fall to fundamentally reasonable levels and banks slowly absorb otherwise potentially fatal loan losses. I wouldn’t look for real estate prices to rise because of the FHA, but the FHA will slow the rate of the fall and move some of the losses to the government balance sheet to buy time for the banks to heal their balance sheets. Yes it costs money, but the end cost will probably be far less than the trillion plus dollars spent to fight wars in the middle east and probably won’t take nearly as long as it will to find Osama.

  43. 43
    b says:

    I think there is really one reason defaults are rising, which Tanta at CR really drove home: no or trivial down loans to unproven buyers. FHA requires 3.5%, which in much of the country is now fully covered by Uncle Sam anyways.

  44. 44

    Hey Jillayne, congrats on your first guest post at SB.

    I’d like to know what you define as an FHA approved lender… “Today, FHA allows the FHA-approved lenders to appoint and train their own underwriters!”

    It’s not very easy to become an FHA/HUD Direct Endorsed approved lender (not sure what level you’re talking about which is why I’m asking for clarification).

  45. 45

    BTW FHA is tightening up their guidelines… FHA Streamline refi’s (I know I’m going to hear groans after typing this) will now require employment to be verified (thank GOD) and will have credit score requirements.

  46. 46
    Jonness says:

    “If the supply of dollars grows while the goods and population stays constant, then the dollar value of the goods erodes, and thus the price of goods grows.”

    That is only true if the increased money circulates through the economy with flat to rising velocity. If the money is kept as reserves, it loses its inflationary effect (i.e. M2=m/R).

    “For some reason a “trade deficit” with my local Starbucks is just fine, but a “trade deficit” with China is a bad thing.”

    You are not borrowing money from Starbucks to buy the coffee. If you were, what would happen if you walked into Starbucks and tell them you are going to pay them back with money that is only worth half as much as they loaned you? They would cut you off the crack, and once all the other dealers learne about it, you’re days with the glass pipe are finished. It can be viewed as the best thing that ever happened to you, but the pain you experience during the transition won”t be much fun. As for Starbucks, it learns a lesson it won’t repeat.

    It is not a good thing to live beyond your means by using borrowed money. If you continue to do it long enough, as mentioned above, you reach the saturation point.

    We always feel good when we first take out a loan and are partying with the money. The problems start when our debtors start to question our ability to pay back the money.

  47. 47
    AMS says:

    RE: Jonness @ 46

    This is true: “That is only true if the increased money circulates through the economy with flat to rising velocity. If the money is kept as reserves, it loses its inflationary effect (i.e. M2=m/R).”

    Similarly, as long as the velocity does not change, the money supply can contract without deflationary effect.

    Propensity to spend, save, taxation rates, and so on must change just perfectly if the velocity is to remain constant with a changing money supply. Possible, yes. Probable, no.

  48. 48
    Jonness says:

    “it loses its inflationary effect (i.e. M2=m/R).”

    Sorry, my notation is sucky. That should be M2=MB/R. The point is FHA defaults will rise if home prices continue down. The question is can we inflate the dollar so that money becomes worth less but people aren’t technically underwater?

    Most people believe inflationary pressure currently outweighs deflationary pressure. But if that’s true, why won’t the Fed up the short-term rate? If the Fed knew inflation was about to take off, it would be highly irresponsible not to raise the rate.

    IMO, we are not in danger of inflation until banks start lending and people start spending. As long as the banks hold money in excess reserves, the increase in the money supply is negated (M2=MB/R). Increasing the monetary base does not automatically mean hyperinflation will hit. First that new money has to circulate and chase goods. So how much money is currently chasing Seattle houses compared to 2005? It seems to me, that’s what matters to whether prices will go down, stay flat, or rise from the current 2005-ish levels. If the answer is, there is less money chasing houses now than then, most likely FHA defaults will rise from current levels.

    “Propensity to spend, save, taxation rates, and so on must change just perfectly if the velocity is to remain constant with a changing money supply. Possible, yes. Probable, no.”

    True, but people spend less when unemployed. I agree we will most likely experience high inflation when the money catches up to us, but I don’t see it happening in the near term.

  49. 49
    homer says:

    RE: Kary L. Krismer @ 24

    actually Kary – analyzing my bank’s losses….those we approved above 700 FICO so far
    I only have one foreclosure….I feel that FICO socres should be a PART of the underwritng process, more importantly is a HARD stop at 43% DTI. Anything above gets declined.

    But I agree with you it is so easy to get a high FICO and have no business getting a home loan.

    So far most of the foreclosures I see are all due to lying about owner occupancy….almost all were flips.

  50. 50
    homer says:

    RE: Rhonda Porter @ 44
    Rhonda,
    It’s SO easy to get approved as a FHA underwirter. I know people who were tending bar two years ago that are FHA underwriters now for two large wholesale companies that have faked their way into underwriting.

    Not like it used to be where HUD issued your number.

    Amazing is the word…but hey….the govt is picking up the tab so this TARP receiving company could care LESS.

  51. 51
    AMS says:

    RE: Jonness @ 48

    “The question is can we inflate the dollar so that money becomes worth less but people aren’t technically underwater?”

    Basically this is the question of “Can the FED get inflation to be such that it is positive, yet not too high, and at the same time stimulate a strained economy?” I find this very problematic. It is going to be a surgical maneuver to heat up the economy, but not overheat it. Very tricky given our situation.

    One thing is for sure, the mass psychological forces have a much lower discount rate than just about each and every one. It reminds me of how long it took the Catholic Church to forgive Galileo. Does it do much good to be forgiven some 400 years later? Maybe his soul has been transferred to a much happier place.

  52. 52

    RE: homer @ 50 – ouch! I don’t know about the qualifications for a wholesale lender w/FHA underwriting. We are a direct endorsed HUD lender and I believe we have more risk involved than what is being implied…however there are different levels of FHA approval w/lenders. It wouldn’t surprise me in the least if it was easier for a bank to have weak FHA underwriters. Our company could not afford that because it would mean “buy backs”.

    I am afraid that with TARP and how much in debt the banks are to the government…the government is now working for them. (As if they weren’t bought all ready).

  53. 53
    Jonness says:

    Aggregate demand (GDP) = MB*V/R. Right now the banks appear to be funneling a large amount of ,what otherwise would be, R into the stock market due to the suspension of mark to market accounting coupled with massive government bailouts. So things are looking fundamentally better at the moment. What’s interesting is what will happen if the markets (considered by many to be overbought) undergo a correction. All that point, money comes out of the stocks and gets shoved back into reserves. Thus, GDP takes a hit, and deflation jumps back into the mainstream mindset (at least for a while). If this occurs, it will equate to another round of house price drops amidst a renewed period of fear. As far as FHA goes, in this scenario, I think it’s toast–despite it’s leader claiming it has $30 billion stashed away for a rainy day.

    Nobody knows for certain where we are headed, but I think most people agree we are still amidst a high degree of risk and volatility.

  54. 54
    Jonness says:

    RE: AMS @ 51 – What do you believe the result will be if we overheat too far?

  55. 55
    AMS says:

    RE: Jonness @ 54

    Overheating too far leads straight to inflation, but I am not suggesting that is what is going to happen. In my opinion the problems in the economy are very deep. For example, it’s tough to drop interest rates when the FED target is essentially zero. What’s next, negative 2%?

    Then we have a problem with the total education of the workforce. While Seattle is one of the more educated areas, which is one of the justifications for inflated prices, the total workforce is not in such good shape. So turning up the heat might not put much in the economy.

    Then there is debt–how do you turn up the heat when you have a bunch of boomers trying to consume in retirement? The promise must come from generations below?

    Oh, and I do agree we are in a very risky position. Volatility isn’t something that I view as bad, but some do.

  56. 56
    AMS says:

    RE: Jonness @ 53

    One more question:

    Where is the critical point at which the United States must inflate the dollar to pay back debt? Of course this could be based on GDP, debt holders switching to consumption, level of debt, and so on. But there must be a critical point where the US will have a problem paying back its debt. It’s not a question of if, but rather, how much.

  57. 57
    David Losh says:

    RE: Jonness @ 53

    You have really put a point to the discussion here and on the Open Thread. These are investor dollars that I am calling a market manipulation. Dumping money into the stock market makes every one feel good, mortgages are being churned, refinance, new purchase mortgages, and it appears as though we are doing business, creating commerce, having an economy.

    As money retreats back to the reserves, or any safe haven, it will suck the life back out of the economy. This time the consequences will be less sever. There are other things to do. We can make money doing other things than trading paper.

  58. 58
    Jillayne says:

    Hi Rhonda,

    Re your question in #44, what I mean by “fha approved lender” this would mean a bank, consumer loan company, credit union, or other non-depository lender that have the ability to fund their own loans. By definition a broker is not a lender so we’re talking lenders only. The vast majority of brand new underwriters I met in 2008 were working for federally chartered banks.

  59. 59
    Jonness says:

    Here is a chart that demonstrates what I’m saying:

    http://housingcorrection.com/misc/MVm.png

    Note how the money multiplier (1/Reserves) has so far directly offset the massive increase in the monetary base. So what’s left is velocity has been declining, thus pushing GDP down. IOW, in order for inflation to hit, the banks must loan, and people must spend. As AMS has alluded, if the Fed gets this wrong, we will pay a hefty price for having undergone such extreme manipulation. If you stop and think about it, that is a very abnormal and scary chart.

    FHA is broke: http://www.washingtonpost.com/wp-dyn/content/article/2009/09/18/AR2009091803578.html?hpid=topnews

    FDIC is broke: http://online.wsj.com/article/SB125328162000123101.html?mod=googlenews_wsj

    Fannie, Freddie, and Ginnie are broke.

    The entire system is a house of cards.

    The stock market continues to soar pricing in a massive V-shaped recovery.

    ” We have three main problems leading to this dramatic rise in FHA defaults:

    1. Pressure from government to use FHA for purposes of taking toxic loans off the bank’s balance sheets;
    2. Lack of education, training, and mentoring of new underwriters during the recent, dramatic rise in FHA originations; and,
    3. Lack of a large enough down payment from the homeowner to insure against falling home prices.”

    IMO, it’s all part of the bag of extraordinarily risky tricks to prop up the paper mache economy in a sly attempt to rescue society’s most elite class of criminals.

    We are in a pickle.

  60. 60
    AMS says:

    RE: Jonness @ 59 – Yes, Yes, Yes!

    The fundamental problems have not gone away…

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