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FHA Is Broke. Now What?

This morning, the Washington Post reported that the Federal Housing Administration has been hit so hard by mortgage delinquencies and foreclosures, that the FHA would officially drop below the cash reserve level required by Congress.

The problem is two-fold: Congress requires FHA to keep 2 percent of all outstanding loans in cash reserves. As the number of FHA loans has increased exponentially (it is now cheaper in many cases to get an FHA loan than a conventional loan), FHA must keep 2 percent of a much larger number in cash reserves. On the other hand, a growing number of FHA loans are failing, requiring FHA to dip into those cash reserves to pay off FHA foreclosures.

In an interview with the Washington Post, FHA Commissioner David H. Stevens said, "There's nothing more serious that we're addressing right now, outside the housing crisis in general, than this issue."

There are only two ways to truly fix the problem: Increase the amount of mortgage insurance charged to borrowers on FHA loans or ask Congress to dump billions into FHA's cash reserve fund.

Neither is politically palatable, as the Washington Post observes. If you cut back on FHA and its 3.5 percent payment requirement, you'll cut the housing recovery off at the knees. Most of the people who use FHA loans don't have enough cash for a 10, 15, or 20 percent down payment. And, that's really what you need to get a Fannie Mae or Freddie Mac loan.

But by the same token, if you jack up the mortgage insurance premium you pay for life with your FHA loan, you'll price some first-time buyers out of the market. Since first-time buyers are the lifeblood of the housing market at the moment, anything that crimps affordability could potentially damage the resurgent market.

The easy, though politically stinky move, is to have Congress simply change or eliminate the amount of cash reserves FHA is required to have and then dump more money into its coffers - perhaps structured as a loan, since FHA has never needed a dime of taxpayer money since it was founded in 1934.

If the cash is structured as a loan, FHA can repay it when times get better.

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