In light of this, the FHA has taken steps to shore up its reserves and tighten the market for its loans in the past few years. The agency increased its upfront premium to 1.75 percent, and annual premiums have increased to more than 1 percent. In addition, borrowers with credit scores below 580 are required to have larger downpayments than the 3.5 percent minimum, and seller-assisted downpayments are no longer allowed. The agency also created an office of risk management.

Although these are steps in the right direction, it remains to be seen if these measures will be enough to offset what could be massive losses. “[The FHA will] have to improve their book of business if they are not to go to Congress and ask for money,” Gumbinger says.

“FHA takes the garbage, basically. They’re still a semi-subprime lender,” says Michael Meena, president of Augusta Financial Inc. Meena originated more than $40 million in FHA loans in 2011 and continues to do a significant portion of FHA-based business. “I believe that the credit requirements now may be a little bit low,” he says. “I don’t think it would kill the market if FHA said, ‘Our credit score requirements are 640 or 660 or even 680, instead of 580.’ I guarantee you those 580s don’t perform.”

FHA officials maintain that loans insured since 2009 are higher quality and eventually will lower delinquencies. The agency anticipates that its reserves will be restored by 2014, barring a second recession.

The B word

What the future holds, however, remains to be seen. With FHA reserves so slight, further economic malaise or increasing delinquencies could require the FHA to seek a taxpayer-funded bailout.

“Housing is a long-lived asset,” Caplin says. “Its value depends today on what you think its value will be in the future. We have no idea what the future holds. There is no policy in place to make the future different from today. There’s every reason to be very worried.”

It’s especially troubling because the FHA plays such a significant role in the housing industry today. “FHA is a staple,” Meena says. “It’s probably 30 percent of our business.” Although he has seen a small drop-off in FHA business in the past few years, he attributes that more to conventional lending starting to step back into the market than FHA tightening its standards.

It’s unlikely that FHA’s market share will decline significantly in coming years, Gumbinger says. “I think they would like to return to their traditional role, but I don’t think in this set of market conditions — and market conditions for the foreseeable future — that they’re going to be able to pull back very quickly.”

Further measures from the FHA probably will be necessary when all is said and done. “It’s likely that the standards for FHA are going to need to be tightened as we move forward to push more people back into a hopefully resurgent market and to rebuild the finances so that the program runs for those for whom it was originally intended,” Gumbinger says.

As for the bailout question? It depends on who you ask.

“There’s no doubt that the FHA will be bailed out,” Caplin says. “The only question is: Is it in reality already being bailed out?”

Gumbinger gives it 50-50 odds. “If things heal going forward — job growth gets better, income growth gets stronger, household formation begins to pick up, [gross-domestic-product] growth is better — all those things would help support making monthly payments and support property valuations,” he says.

Whatever may happen, Gumbinger says, it’s an issue “that’s going to be with us for awhile.” 

Jennifer E. Garrett is editor of Scotsman Guide. Reach her at (800) 297-6061 or jenniferg@scotsmanguide.com.

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