FHA's Net Capital Ratio Falls to .53%

Late last week the FHA released its long anticipated annual update report to Congress. As expected, the report highlighted the significant financial duress within the agency’s portfolio. Specifically, the FHA’s capital reserve ratio fell to .53% vs. a 2% mandated level and 2008’s cushion of 3.22%. While the agency’s leadership continues to believe it will not need a bailout, most close observers of the housing market (including myself) see little chance of that scenario playing out. Even within the guts of the FHA’s report, the agency does concede that under certain pricing scenarios the agency will eat through its entire capital buffer (though this will be temporary as a robust housing recovery will enhance the agency capital position beyond 2011).

While absorbing the FHA’s losses will be relatively small, particularly when compared to the hundreds of billions of dollars needed to prop us Fannie & Freddie, my concern is how distorting the FHA’s involvement has become. Private commercial lenders have been shut out of the market since most are unwilling to match the lax underwriting standards and high LTV ratios available through the FHA. Government involvement has enhanced affordability for marginal buyers, but derailed the inventory & pricing correction needed to bring the housing market to a healthy equilibrium. How sustainable is a market that requires a maximum 3.5% downpayment, $8,000 tax credit, and artificially low mortgage rates (less than 5% at current rates) to entice the incremental household to buy a home? Obviously, not very. The longer we put off the day of reckoning the more painful the correction will ultimately be.

At the end of 2008/beginning of 2009, I was very encouraged that housing was quickly finding a bottom. While pricing and new construction were breaching new lows each month, the inventory was starting to clear and real buyers (not 600 FICO subprime borrowers or speculators) were finding their way into the market. Pricing was falling to levels where the rent vs. buy equation was just too enticing for judicious savers that sidestepped the madness of 2004-2007 to pass up. However, with the strong hand of government manipulating the market, that price/inventory correction has reached a grinding halt.

It could take some time for the government to withdraw its stimulus from the housing market, particularly with the 2010 elections quickly approaching. Politicians hate to disrupt the apple cart lest it interfere with their #1 goal of getting reelected. However, until housing reaches a point where it can stand on its own, the apparent “recovery” evident in the incrementally positive data remains highly elusive in my opinion.