FHA Study Says Technical Issues Understate Loan Risks
We wrote today about this paper from economists at the New York Federal Reserve and New York University that argues that the Federal Housing Administration may be missing certain warning signals in its annual audit that could underestimate losses.
The FHA says that it disputes both the characterizations of its annual audit and the conclusions of the study.
One interesting claim that the study makes concerns the way in which the FHA treats so-called “streamline” refinance transactions where existing FHA borrowers are allowed to refinance even if the value of the loan equals or exceeds the value of the home. Those loans are more likely to be underwater, the economists argue, than the FHA methodology suggests, which could lead to risks that aren’t accurately reflected in the annual audit.
To be sure, the agency already owns the risk on those loans, so it’s not necessarily bad policy to allow those borrowers to refinance and take advantage of a lower rate. The authors argue that the agency, however, isn’t properly accounting for big uptick in those loans, which hadn’t been heavily used until home price declines accelerated two years ago.
The problem isn’t with the actual loans, per se, but with the way in which they’re accounted for in the review. When a loan terminates — either because it’s paid off, it defaults, or it refinances — the review puts it into either a “good” bucket or a “bad” bucket. Refinances are classified as “good” terminations because the existing loan is paid off without requiring the FHA to pay a claim, or reimburse the lender, for a loss. In the past, that wasn’t a problem, because streamline refinances weren’t heavily used–borrowers were refinancing out of the FHA, and the loan was history.
But as streamline refinances have picked up, more loans are being counted as “good” terminations when, in fact, the risk hasn’t gone away for the FHA.
Unfortunately, while streamline-refinancing terminates a particular mortgage, it does not terminate the underlying risk to FHA. It is neither a Bad nor a Good termination, but rather an entirely different event. Including streamline refinances in the Good group artificially inflates the size of this group.
That, in turn, skews the estimates used to predict the probabilities surrounding future loan performance. “The inappropriate treatment of streamline refinancing is but one part of a larger problem” with the agency’s models, the authors conclude.
Agency officials said they welcomed the analysis, but disagreed with the conclusions and stood by the review as conducted. “We think based on their review, they’re overstating” the problem, said one senior agency official who had seen an early copy of the study. “They’re misapplying the way that they look at that differential.”
March 06 2010 02:09 am | Real Estate News
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