FHA Mortgage Meltdown Coming

For generations, these loans, backed by the Federal Housing Administration, have offered working-class families a legitimate means to purchase their own homes. But now there's a severe danger that aggressive lenders and brokers schooled in the rash ways of the subprime industry will overwhelm the FHA with loans for people unlikely to make their payments. Exacerbating matters, FHA officials seem oblivious to what's happening — or incapable of stopping it. They're giving mortgage firms licenses to dole out 100 percent-insured loans despite lender records blotted by state sanctions, bankruptcy filings, civil lawsuits, and even criminal convictions.

As a result, the nation could soon suffer a fresh wave of defaults and foreclosures, with Washington obliged to respond with yet another gargantuan bailout. Inside Mortgage Finance, a research and newsletter firm in Bethesda, Md., estimates that over the next five years fresh loans backed by the FHA that go sour will cost taxpayers $100 billion or more. That's on top of the $700 billion financial-system rescue Congress has already approved. Gary E. Lacefield, a former federal mortgage investigator who now runs Risk Mitigation Group, a consultancy in Arlington, Tex., predicts: "Within the next 12 to 18 months, there is going to be FHA-insurance Armageddon."

During the subprime boom, the FHA atrophied as borrowers migrated to the too-good-to-be-true deals that featured terms such as extremely low introductory interest rates that later jumped skyward. But since the subprime market vaporized in 2007, FHA-backed loans have become all that's available for many borrowers. By fall 2008, FHA loans accounted for 26 percent of all new mortgages being issued nationwide, up from only 4 percent a year earlier. As of Sept. 30, the most recent date for which data are publicly available, the FHA had 4.4 million single-family mortgages under guarantee, worth a total of $475 billion.

Congress and the Bush Administration are strongly encouraging lenders to apply for FHA approval and tap into the government's loan-guarantee reservoir. In September, the agency guaranteed 140,000 new loans, up from 60,000 in January. In October, as Congress and the White House scrambled to respond to the spreading financial disaster, the FHA began to extend $300 billion in additional loan guarantees under the banner of a new program called HOPE for Homeowners. The limit on the amount buyers may borrow will rise in January to $625,000 from $362,790 in 2007.

Some current and former federal housing officials say the agency isn't anywhere close to being equipped to deal with the onslaught of lenders seeking to cash in. Thirty-six thousand lenders now have FHA licenses, up from 16,000 in mid-2007. FHA "faces a tsunami" in the form of ex-subprime lenders who favor aggressive sales tactics and sometimes engage in outright fraud, says Kenneth M. Donohue Sr., the inspector general for HUD. "I am very concerned that the same players who brought us problems in the subprime area are now reconstituting themselves and bringing loans into the FHA portfolio," he adds.

Goldman's dealings suggest another reason FHA-insured lending is booming: The federal guarantee creates an incentive for banks to buy FHA loans and bundle them as securities to be sold to investors. This is happening as the securitization of subprime and conventional mortgages has largely ceased.