FHA: The New Subprime

Three facts:

  • Nearly 7% (and rising) of FHA loans are currently in default (source).
  • The FHA has cash reserves of less than 2 percent (and falling) of the total value of loans they guarantee (source).
  • FHA currently makes about 23% (and rising) of all mortgages in the USA (source).

Here are those first two points presented graphically:

FHA Loans

I’m trying to imagine a realistic, plausible scenario in which the FHA isn’t essentially doomed to be the next big Federal bailout, and I’m afraid to say, I’m coming up empty.

About The Tim

Tim Ellis is the founder of Seattle Bubble. His background in engineering and computer / internet technology, a fondness of data-based analysis of problems, and an addiction to spreadsheets all influence his perspective on the Seattle-area real estate market.


  1. 1
    patient says:

    I have no doubt that FHA will blow up. The question is how much patience do the american people have with further massive bailouts? Mine ran out before the TARP program and what I understand so did the majorities since that program was highly unpopular. This will not be an easy sell with mounting fear and realization of the problems that will follow the huge national debt. And having declared recession over and a housing bottom should not make it any easier to explain why FHA needs to run a negative business model.

  2. 2
    Ryan says:

    Not sure if anyone follows the market ticker website but I am sure a few of you will find it worthwhile. Tim, it will probably give you some ideas for future topics of discussion. Take a look at the second story on the page discussing FHA.


    Also take a look at the post under “games banks play (wfc)”…interesting stuff.

  3. 3
    Indy says:

    Well, I agree it will need, and get, a massive bailout. But here’s a possibility.

    If “Cash Reserves” does not include allowance for loan and lease losses (ALLL), and the FHA has already fully funded this allowance account to the level needed to withstand all the losses they will experience on their existing portfolio of loans, and they make a decent profit on the large number of loans they’ve been writing recently, THEN they might just survive without needing a capital infusion from the Treasury. A similar scenario is in the works for FDIC.

    Realistically though, it’s time for Uncle Sam to get his checkbook ready.

  4. 4
    The Tim says:

    By patient @ 1:

    The question is how much patience do the american people have with further massive bailouts? Mine ran out before the TARP program…

    I can taste the irony… ;^)

    RE: Ryan @ 2 – Denninger’s on my daily reads list. Great site, if you can get past the occasional over-the-top presentation.

  5. 5
    Ryan says:

    RE: The Tim @ 4

    Sorry…i am behind the curve here….he is fairly new for me.

  6. 6
    The Tim says:

    RE: Ryan @ 5 – No need to apologize at all. Like I said, great site. Here’s probably the most well-presented post recently, IMO: WARNING: Deflationary Collapse Dead Ahead. If I didn’t know better, I’d probably think Sniglet and Denninger were the same person :^)

  7. 7
    Lake Hills Landlord says:

    RE: The Tim @ 6

    Of course! Why didn’t I think of it. Ok Karl, I mean Sniglet, the game is up!

  8. 8
    ray pepper says:

    RE: The Tim @ 6

    Denninger makes me wanna take up drinking or at the very least go to a Monster Buffet…………….Good God!

  9. 9
    The Kid says:

    After reading that, nybody here still think my French Revolution comparison is still bunk?

  10. 10
    Nick says:

    The absolutely, repugnantly, should-be-criminally reprehensible thing is that EVERYBODY knew that the FHA loans were going to be largely bad; everybody. Unless the FHA has a blank check written out to “taxpayer money black hole”, and an explicit section in their charter / mission statement to funnel taxpayer dollars to irresponsible home knife catchers and propagate financial malfeasance in the US, every single person in their management should be fired and brought up on charges. That includes the malicious morons in Congress who allocated even more money for the FHA to flush, even after everybody realized how bad what they were doing was; and they are still doing it today.

    Hang ’em all, imho.

  11. 11

    And Here’s the One to Blame in March 2008

    Article in part:

    “…Washington, DC – House Financial Services Committee Chairman Barney Frank today announced new legislation to stem the significant rise in mortgage foreclosures by allowing the Federal Housing Administration to insure and guarantee refinanced mortgages that have been significantly written down by mortgage holders and lenders….”

    The rest of the URL:


  12. 12
    patient says:

    RE: softwarengineer @ 11

    The thing is that I have still not understood if B. Franks and C. Dodd are just utterly incompetent and think they are some how doing the right thing by bankrupting us or if they have an agenda driven by some sort of kick backs from sponsors in the banking and re-industry.

  13. 13
    Niz Monkey says:

    But if we stop lending money to people that have absolutely no financial foresight or ability to repay, how do we keep the bubble-blowing machine in high gear?

  14. 14
    Agent says:

    You make the assumption that the 7% of the loans have no value whatsoever… If the FHA used all of their 2% reserves for those loans it would be enough to cover them at 72% of their face value. That means all of the loans would have to average under 72% in value for FHA to be insolvent and need more money from the gov.

  15. 15
    Jillayne says:

    I just read a newsflash (no link) that FHA is going to tighten their underwriting guidelines in response to today’s story about high defaults.

    They’re about 2 years too late, which is typical when working with the government.

    Yes, it was very easy to see that FHA was going to be used by the politicians to take the bad loans off the books of the banks and refinance them into new Fannie, Freddie and FHA loans.

    FHA was never, ever intended to be used to lend money the way that subprime lending worked, which was to lend money to people with poor credit at a higher interest rate.

    FHA has always maintained decent underwriting guidelines that followed the four Cs: Character (credit), capacity, collateral, capital. I can tell countless stories of LOs who, during 2008 and 09, reported that their subprime-type borrowers could not qualify for an FHA loan. Many, many were and are being declined.

    Tim, I need to write a guest post for you explaining the real problem that happened with FHA during the last 2 years that would help explain one major problem behind the delinquencies we’re now seeing.

    The second major problem is downpayment! We “just” modernized FHA to require a 3.5% downpayment!

    3.5% !

    And all of the downpayment can be in the form of a gift from a relative!!

    That’s not nearly enough incentive for the homeowner to keep making their payment when times get tough. People who purchased or refinanced in 2008 on FHA are likely underwater today in many areas.

    We need to require larger downpayments and we need to tighten up internal controls on the bank underwriters, stat.

  16. 16
    Nathan says:

    What about the PMI that everyone is paying into? Surely these mortgages are actually insured…

  17. 17
    Jillayne says:

    Hi Nathan,

    Yes you’re correct. FHA is suppose to be a self-supportive mortgage insurance program. The borrower pays an upfront mortgage insurance premium at closing and then they pay a monthly mortgage insurance premium.

    Premiums offset losses….until now.

    No taxpayer dollars are suppose to go to fund FHA. The entire insurance program is suppose to be self supportive!

  18. 18
    Kary L. Krismer says:

    RE: Nathan @ 16 – PMI is conventional, not FHA, although FHA has something similar built in.

    And as I think Jillayne said, FHA is not the new sub-prime. FHA is what it’s always been, and even a little (.5%) tougher, but it’s now the low end. Before sub-prime ended, it was the middle.

    Rather than focus on the down payment amount, I’d focus more on the source. I think it was only about a year ago they got rid of the scam where the seller could contribute the down payment through a (bogus?) charity entity. I would guess that those loans are a large portion of the defaults we’re seeing today. Even still they allow the down payment to be a gift from a relative. Those will probably be a large portion of the current era loan defaults, but it has nothing to do with skin in the game. It has to do with the fact that someone you did not save a down payment while not owning a house will not be able to make payments when owning a house.

  19. 19
    WestSeattleDave says:

    RE: Jillayne @ 17 – Hey the Tim — I vote for a guest spot by Jillayne on the FHA mess. Maybe we can call her “the Jillayne”!

  20. 20
    Jillayne says:

    Right, Kary. FHA is not a lender. FHA is a mortgage insurance program. Banks are the lenders, FHA (which is under the jurisdiction of HUD) insures the top equity position. If the bank forecloses, FHA will reimburse the lender for losses suffered up to a certain dollar amount. FHA sets the underwriting guidelines. Banks and lenders can go tougher than FHA’s guidelines, they just can’t go weaker.

    Kary you’re referring to the seller downpayment assistance programs. Those stopped in mid 2008 and the result was catastrophic. Early payment defaults on those programs was horrifying. What reportedly happened in some areas is that builders used the program to quickly find straw buyers and get rid of their excess inventory. Tons of these defaults were new construction.

    The new defaults are likely a result of poor underwriting, economic related job losses, and negative equity,

  21. 21
    Jillayne says:

    West Seattle Dave, me and my big ego thought I was one of the only Jillaynes on the planet, until facebook came around and now I see that this is a more common name in the mid-west than I thought. I’ll write the post and shoot it over to Tim. Nothing better to do. The little one is at soccer practice and the big one is watching a tennis match at the high school (cute guys I’m sure) and then she’ll be watching the football game.

  22. 22
    patient says:

    The downpayment is for sure the issue. 3.5% do not make people cautious enough, to little skin in the game and with a national YoY home price decline rate that far exceeds 3.5% it’s extremely irresponsible by the gov. It’s a setup for failure of the borrower and FHA. It’s ran outrage and needs to be addressed.

  23. 23
    Kary L. Krismer says:

    RE: Jillayne @ 20 – Given how long it takes for a default to become a claim, I’d guess most of the problem reported today is due to those “charity” cases. If it was just over a year ago that it stopped, a lot of them are probably still hitting the system today.

  24. 24
    Kary L. Krismer says:

    By Jillayne @ 20:

    Right, Kary. FHA is not a lender.,

    You could have just as easily said: Wrong, Kary. FHA is not the lender.” I wasn’t really focusing on that issue, only pointing out that PMI is conventional. The P is for private, as in non-government. So I really should of said “FHA is something similar.”

    BTW, Jillayne, do you remember what both PMI and FHA insure? From memory I don’t think either of them insure the first dollar of loss, but I’m not even certain of that.

  25. 25
    wreckingbull says:

    RE: The Kid @ 9 – I agree that we will see a major societal breakdown in our lifetimes, due in part to the reasons presented by Denninger. The reactor has already gone critical, and there is no stopping it.

    Before you buy that Ballard bungalow or that home on the new light rail line, think about where you want to live when things go pear-shaped. This played a non-trivial role in my exodus from Seattle last year.

  26. 26
    Jillayne says:

    Hi Kary,

    in the lending industry, we say PMI when we think of private mortgage insurance on a conventional loan and MIP when we think of FHA’s mortgage insurance premium. Trivial but it helps separate the two in conversation.

    The FHA insurance program insures the lender against losses up to the amount of the policy, in the event of default. In terms of specifics, we would have to read through the entire HUD 4155 policy manual and then cross reference with the section of RESPA that specifically addresses loan servicers, and then read through FHA’s Single Family Servicing manual. Quite a task.


  27. 27
    David Losh says:

    What the chart fails to show is price declines.

    It amazes me every day to see sold signs on properties. I look at the prices and think there is the possibility to get them paid off, but why would any one pay down at least a 20% decline in equity.

    Jillyanne is talking about larger down payments when the problem is that those are real dollars some one will be losing. People ask me twice a week, at least, if I truly believe prices will decline 20% from today and I say absolutely, there is no question, and there is nothing else that can happen.

  28. 28
    Kary L. Krismer says:

    RE: Jillayne @ 26 – What each covered (at the time) was included as part of the real estate licensing courses, but it not being something I really needed to know, was something I’ve not remembered. Funny how things work that way.

  29. 29
    The Kid says:

    RE: wreckingbull @ 25

    Honestly, moving out of the area to somewhere more… rural. Closer to a food source and further away from major population centers isn’t a bad idea. Problem being, things are still overpriced even in rural areas. The bubble wasn’t just confined to major metro areas, and then comes the challenge of finding paying work out in BFE. I have a friend who just moved out to live with his father in Yelm, because he couldn’t find anywhere to park the RV that he is forced to live out of. I went out to visit him last week. Unless you’re looking at moving into a double-wide, it’s still pretty pricey out there, and unless you like picking fruit for sub-minimum wage there is basically no work. It was really interesting meeting the people out there. Either retired BABs who moved out there to get away from city life, tech workers who can telecommute for everything, or, pardon the stereotype (but if the shoe fits), toothless rednecks and immigrant agricultural workers. Yikes.

  30. 30
    DrShort says:

    By Kary L. Krismer @ 28:

    RE: Jillayne @ 26 – What each covered (at the time) was included as part of the real estate licensing courses, but it not being something I really needed to know, was something I’ve not remembered. Funny how things work that way.

    PMI pricing and availability is about to undergo a revolution. They days of everyone paying the same PMI rate will be gone in 12 months. It will soon be like auto or home insurance with higher risk borrowers paying A LOT more than well qualified borrowers.

  31. 31
    Scotsman says:

    Chill, people- the government can just print up some dollars to cover the losses and tax the rich to make it all work out. You must all be racist or something to want to prevent the poor from having their shot at getting on the property ladder, getting some of what they deserve for their labors, and having a bit of the American dream. Lighten up- Obama knows what he’s doing along with BB, TG, , etc.- it will all work out.

  32. 32
    omit says:

    When I see these numbers I must imagine that even the the defaults have some return value. The direct comparison of defaults to cash reserves does not hold total confidence. I imagine in only very few circumstances would the default over value be more than 20%.[80%LTV] So take 20% of the items on the left does that scale to the right, yeah that’s less than the reserves, not by much but still less. That’s a loss. The loss on the customer side is shifted to the note holder. You know it seems when anything in the market becomes a dogpile situation, it becomes toxic. the .com bust. the realestate bust. Whenever EVERYONE starts to do it and it becomes a buzz word, that’s the time to GET OUT

  33. 33
    Jillayne says:

    Dr. Short,

    FHA already uses risk based pricing with the more risky borrowers paying a higher mortgage insurance premium (MIP) than borrowers with great credit scores.

    Private mortgage insurance companies are hurting. The next 6 months are going to be interesting!

  34. 34
    Mama says:

    RE: Jillayne @ 32 – Can you elaborate — I was told that as long as all borrowers clear the FICO 640 mark it doesn’t matter. We were worried about one person being below 750 and our LO said this would make no difference at all — did they lie to us? AFAIK the upfront fee is always .175% Loan and the MI is 0.05 (on FHA, that is)

  35. 35
    S-crow says:

    RE: Jillayne @ 15

    I hope you take a moment to discuss FHA Streamlines ….no appraisal. Ripe for default in this environment.

  36. 36
    James Hua says:

    @ tim – i like your “fha loan” graph, but i think it can be misleading. you’re showing a straight comparison that 7% of loans are in default while fha only has 2% in loan loss reserves. the real number that needs to be compared is the expected loss of the loans.which depends on what quality of borrowers, underwriting and a variety of other factors. and this loss can range from a few percent to 40% and beyond.

    banks typcally use tier 1 capital requirements as a measure of health which is ultimate the ability for banks/financial institutions to weather storms. in this case, i assume there would be no equity, but you would take into account cash on hand as well as cash reserves.

  37. 37
    Jillayne says:


    It depends on when you received your FHA loan. They began risk based pricing in 2008 as planned, only to have the whole thing postponed until…I believe it will start back up again Oct 1, 2009. I don’t think your LO lied to you.

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