Are You Ready For The Next Mortgage Crisis?

George Yacik - Contributor - Fed & Interest Rates

As an avid observer of the U.S. residential mortgage scene, I couldn’t help but take a keen interest in one of the lead articles in the Wall Street Journal on Thursday. The article was headlined, “The Mortgage Market’s $1 Trillion Pocket of Worry.”

According to the article, bonds backed by “certain risky single-family mortgages topped $1 trillion for the first time in November.” I wasn’t sure what “certain risky” mortgages they were talking about, so I read on. It turns out they are mortgages insured by the Federal Housing Administration (i.e., taxpayers) which, as the Journal noted, “typically go to borrowers with small down payments and lower credit scores.”

While I certainly know what FHA mortgages are, who they go to, and that their market share has been growing sharply since the mortgage meltdown eight years ago, the Journal article was useful in telling a wider audience about yet another government financial crisis in the making. But the article largely skated over another fairly important aspect of the story.

Just a week earlier, in another act of last-minute taxpayer-funded generosity proffered by the outgoing Obama Administration, the FHA announced that it is cutting its annual mortgage insurance premiums for most new borrowers by 25 basis points. Yes, you read that correctly. The FHA is cutting premiums, not raising them, even as the risk pot is growing.

If you had read a similar article that said that automobile insurance companies were suddenly hit with an influx of bad drivers, and their response was to lower insurance premiums, not raise them, wouldn’t you think the insurers were nuts?

Yet, what’s going on in the mortgage market has attracted relatively little notice, until the Journal finally reported it. In fact, the general response among mortgage lenders to the FHA premium cut was positive. And why shouldn’t it be? It creates more business for them, never mind the risks.

In a statement announcing the premium cut – which, by the way, is the FHA’s second such reduction in the past two years – outgoing HUD Secretary Julián Castro said that the cut aligns FHA pricing with “today’s risk environment” and “comes at the right time” for borrowers, who now face higher mortgage interest rates.

“After four straight years of growth and with sufficient reserves on hand to meet future claims, it’s time for FHA to pass along some modest savings to working families,” Castro said. “This is a fiscally responsible measure to price our mortgage insurance in a way that protects our insurance fund while preserving the dream of homeownership for credit-qualified borrowers.”

Castro was referring to the fact that the FHA’s mutual mortgage insurance fund, which backs the loans it insures, reached 2.3% of loan outstandings in fiscal 2016, well above its Congressionally mandated threshold of 2%. In other words, what’s the problem?

But according to the Journal story, “FHA loans have been the worst performers among all major mortgages for years. Just over 4% of FHA mortgages were at least 90 days past due in October, according to the FHA.” That’s about double the 2% delinquency rate on loans eligible for purchase by Fannie Mae and Freddie Mac, which have tighter underwriting guidelines.

At the same time, the FHA’s share of the overall mortgage market has grown far larger than it was before the housing bust. FHA market share since then has been averaging in the low to mid-teens, compared to less than 5% before the bust. Likewise, the amount of mortgage-backed bonds the government guarantees has jumped significantly. Back in 2007, the agency guaranteed only $272 billion of mortgages, compared to today’s $1 trillion. That doesn’t include another $700 billion from other government insurance programs, like the VA mortgage program.

There’s an additional wrinkle the Journal article did focus on. Commercial banks have largely abandoned the FHA market, citing increased risk, leaving it to nonbank mortgage lenders to fill the void. According to Inside Mortgage Finance, an industry publication, banks now account for less than 10% of the FHA market, compared to more than 60% six years ago, while nonbanks’ share has grown to 80%.

“This is the biggest shift in mortgage lending since the savings-and-loans debacle in the 1980s,” Ted Tozer, the head of the Government National Mortgage Association, which guarantees the bonds backed by FHA loans, told the Journal.

If things are so rosy, why are the banks leaving the market? No less a figure than JPMorgan Chase chairman and CEO Jamie Dimon said in a letter to shareholders last year, “It simply is too costly and too risky to originate these kinds of mortgages.”

So which version of the story are we supposed to lend greater credence to? The Journal’s article about the burgeoning risk and size of the government-insured mortgage portfolio, or the all-is-well version from the outgoing Obama Administration?

When Ben Carson’s nomination to HUD secretary was announced a few weeks ago, many people hooted it down. What does a retired neurosurgeon know about the mortgage and housing business, they asked? We need “experts” to run HUD, they said. I say Dr. Carson can’t get here fast enough.

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George Yacik Contributor - Fed & Interest Rates

Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from for their opinion.

6 thoughts on “Are You Ready For The Next Mortgage Crisis?

  1. This fact is not limiting for Mortgage market only, but also it can be uniformly apply to Derivatives and hedge fund funding and loans and advances, given to big industrial sectors too. Currency exchange rates manipulation is also at it's pick, liabilities and obligation of Governments of so many countries entered in a "Too big to Bail" level.

    Available picture is not reflecting fact, and no picture is available which is expressing fact. All most published data is either illusive or fake, and will continue to release in same manner, until they will manage to do so.

    Wisdom clearly point-out that we must be ready to face next multiple financial crisis and sudden shocks.

  2. Very detailed Article George! Thanks.

    Government and whole financial sector never ready to get some lessons from 2007 -2008 Crisis, and probably, in future too, they can't, and why they do so? because when they are having an opportunity to keep their own vested financial interest at the cost and consequences of "Tex payers Fund"

    A big very big and an ultimate bubble appeared Real estate sector, Not just in US, but now it has captured whole world by and large, also the same became so risky that it will burst, destroy entire financial sector.

  3. I like your article, George and share the opinion that the next housing boom and bust is possibly coming our way. Real estate prices are rising exponentially, especially in large cities, but smaller ones are also witnessing home price rises, due to a huge influx of population from rural areas in search of better-paid jobs, but for whom living in large ones is beyond their means. There are likely to be further interest rate increases by the FED in 2017, but this will definitely not cool the housing market down, since, as you say in the article, banks are not following in step, by way of offering looser credit terms and lower fees. Furthermore, the fact that these loans will be backed by Fannie Mae and Freddie Mac can only send shivers down one's spine. Construction activity is also booming, but everything is relatively tolerable until demand outstrips supply. That's when we can expect the bubble to burst and the collapse of the whole financial system. As one of the readers above mentioned, it is at this moment that taxpayers will come to the fore, to bear the burden and bail them out. Hopefully, Dr Ben will do something. 🙂
    But, like everything else in economics, nothing is entirely black or white. There may be a silver lining for investors in real estate, on condition they choose the right timing to enter and exit the trades.

    Good trading!

  4. The question should be why are people selling these bonds... taxpayers having to bail them out when it collapses is the real scandal, rather than how the govt. sets interest rates on mortgages.

  5. Well you got your Obama shot in. IMHO Dr. Carson is coo-coo for cocoa puffs. Hope I'm wrong.

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