Bearish News

The FHA continues to guarantee risky loans on behalf of the American public. And they’re now backing loans of almost $1m. Clearly, the FHA no longer serves the purpose it was created for – providing responsible loans to low-income and minority borrowers.

The current system simply transfers risk from private lenders to taxpayers. What a deal for lenders – government takes all the risk, and lenders only have to do paperwork and service the loan. With this kind of sweetheart deal, it’s no surprise that banks are reaping huge profits.

Part of recent profits are due to banks setting aside smaller cash reserves to cover losses. But why should they? Taxpayers will mop up the red ink, while banks reap all the gains.  See Freddie Mac, Fannie Mae, AIG, and GMAC for more examples. Quite the recurring theme these days.

Add accounting gimmicks and low interest rates, and voila! Banks look great again. The overall economy, not so much. But banks are cleaning-up.

Excerpt from a great NYT piece.

In January, Mike Rowland was so broke that he had to raid his retirement savings to move here from Boston.

A week ago, he and a couple of buddies bought a two-unit apartment building for nearly a million dollars. They had only a little cash to bring to the table but, with the federal government insuring the transaction, a large down payment was not necessary.

“It was kind of crazy we could get this big a loan,” said Mr. Rowland, 27. “If a government official came out here, I would slap him a high-five”…

Some F.H.A. borrowers here say they have the cash for a full down payment but would rather invest it in the stock market or use it for remodeling. Others, like Mr. Rowland and his friends, simply do not have the money required by private lenders — which would have been nearly $200,000, in their case.

Apparently we haven’t learned much from recent crises. The current strategy is to resurrect the problems that got us into this mess, but on a larger and publicly-backed plan. Push back doomsday a few years if you can.

Take a look at these past FHA pieces if you’re interested, where I uncovered some ridiculous claims from FHA-backed lenders:

#1 – FHA – Bailout waiting to happen?
#2 – FHA dutifully following sub-prime playbook
#3 – Quicken Loans responds

Quicken Loans’ responded to my piece on their FHA-backed loans, I posted it in-full below. Kelly makes some good points, and apparently they’re in the process of changing some programs. But I’m still worried about the quality and quantity of loans being insured by our government.

Hey Adam – Kelly from Quicken Loans here. I just wanted to clear up a few things from our perspective since you mentioned us.

We’re one of the nation’s largest FHA lenders. We’re proud to offer a few different FHA loans, all of which have fixed rates. All also require a minimum 620 credit score, higher than FHA requires normally.

Let’s start with defining balloon mortgages. Typically, balloon loans do not fully amortize and leave a balance due at maturity. Our FHA Rate Break is not like that at all. It is a fixed rate loan that will be paid off in 30 years or sooner, should they client choose to pay it off. Rate Break is most akin to buying discount points, which we all know can get you a lower mortgage rate.

With the FHA Rate Break option (also called a Temporary Buydown), funds are deposited into an escrow account at close and then released in monthly installments that are applied to the mortgage payments over the following 1 or 2 years, depending on the Rate Break option you choose. As a result, the client’s monthly payment obligation is reduced during the term of the plan. Rate Break is only available on home purchases, not refinances.

On the other hand, FHA Streamline is only available as a refinance loan. They’re just as they sound – a streamlined version of typical FHA loans. They require that you currently be in an FHA loan. Because of that, the FHA has more flexible guidelines. They already know a lot about these clients. It’s also worth noting that if the client’s payment goes up with their new FHA Streamline loan (because of shortened term or switching from ARM to fixed), they must “credit qualify” – meaning we have to verify income, assets & credit like a normal FHA loan. Like you said, these streamlined loans are meant to get people out of loans they can’t afford.

In addition, changes to FHA Streamline are coming next month. They’re effective for FHA case numbers issued on 11/17/2009 and after. They include:

- To roll in any costs, the client must obtain a new appraisal
- Discount points can never be rolled in, the client must always pay them at close
- Assets to close must be fully verified
- Verbal verification of employment will be required

We’ve made these upcoming changes available on our website:
https://www.quickenloans.com/mortgage-news/federal-government-revises-refinancing-process-for-fha-streamline-mortgages-5749

Rest assured we always make it our goal to put our clients in the best loan possible. We work hard to educate every client and I wanted to make sure none of the content on our site is taken out of context or explained incorrectly. I hope my explanations make sense to you and your readers. If not, I’m always available for questions.

- Kelly@QuickenLoans.com

Thanks for the opportunity to explain.

Kelly

Agency Offers Low Teaser Rates, Questionable Refi Loans

That’s right, FHA is now insuring mortgages with low teaser rates that balloon after a year. See the last bullet-point in this screenshot via Quicken Loans:

They also require tiny/nill downpayments. And it gets better: No income verification! See the last line in this screengrab from Quicken Loans:

Short-sighted much?

Similar loans, known as Ninjas (no income, no job, no assets) were a major part of the sub-prime debacle. While I’m all in favor of getting people out of loans they can’t afford, this is a horrible way to do it. It rewards the private sector by putting all the risk on taxpayers, while lenders reap all the profits.

See last month’s FHA: Bailout Waiting to Happen for more on the scale of the problem. It’s big, with FHA insuring 23% of all loans made in 2009.

I’ll leave you with one more screengrab:

Disclosure: No position in any companies mentioned

Homebuilders: Short or Steer Clear?

KB Homes missed big today, reporting an $.87 per share loss. Their outlook on the market wasn’t rosy either. They dropped 8.5%. Builders appear to be a good short candidate. But like most industries, one needs to consider government interventions before shorting.

Major HB names are still up more than 100% from their 52-week lows. Kinda makes the S&P 500′s rally look meek:

1. Meritage Homes (MTH) up 307%
2. M/I Homes (MHO) up 198%
3. KB Home (KBH) up 145%
4. Ryland (RYL) – up 111%
5. Toll Bros (TOLL) up 47%

Government Crutch

Since last Fall, when a depression seemed imminent, builders have clearly benefited from government-support. The big question is: How long can this last? The Fed claims to be planning their exit strategy. But they always add a disclaimer, “not too soon“. Meanwhile, the fundamental side has changed little.

Cheap mortgages are here to stay for an extended period. Bernanke and Geithner have made this clear. They will do all it takes to prevent (or postpone) a depression. Cheap rates will buoy builders, but enough? This is where the homebuyer-tax-credit comes in, acting as another gross distortion of markets. Think about those people who bought a day/week/month before the credit passed. “Oh, gosh. You bought your home yesterday? Too bad.”

$8,000 Credit: Double and Expand It, Please

The first-time home buyer credit is scheduled to expire in November. But lobbyists are fighting hard to get it renewed. Congress seems likely to bite, despite our huge deficits. These market-interventions will largely determine the direction of home-builder stocks over the next year plus.

Sen. Johnny Isakson of Georgia, an ex-realtor, has proposed not only extending the credit, but expanding it to a max of $15,000. And he thinks everyone should be eligible in 2010; not just first-time buyers (WaPo). Bailouts and moral hazards don’t show any sign of abating.

So while the administration is under (a little) pressure to shrink deficits, more bailouts will probably pass. Our economic leadership views these market-distorting actions as victimless. Everyone benefits from rising home prices, right? Wrong. What about the millions of renters who are going to face higher taxes, due to drops in tax revenue? And what about responsible savers who have been waiting for homes to drop into their price range? They get screwed.

The Dreaded Spillover Effect

There would be a spillover effect on the broader economy if housing prices dropped. But do we really want to return to the days when houses were ATMs? Clearly that’s not sustainable. And despite falling prices, house valuation ratios remain out-of-whack. In a recent piece titled Falling House Prices Are The Solution, Not The Problem Patrick Killelea wrote:

It’s still much cheaper to rent than to own the same size and quality house, in the same school district. On the coasts, yearly rents are less than 3% of purchase price and mortgage rates are 6%, so it costs twice as much to borrow money to buy a house than it does to borrow (rent) the house itself. Worse, total owner costs including taxes, maintenance, and insurance come to about 9% of purchase price, which is three times the cost of renting. Buying a house is still a very bad deal for the buyer on the coasts, but it does make sense to buy in Michigan and some other places where prices have fallen into line with salaries and rents.

Shifting to a non-supported housing market too quickly would have negative effects. But we need to let housing prices fall much more than we have. It’s important to remember that we are fighting fundamental market forces here. Even the US government can’t really “win”. Something’s gotta give, someone has to lose. Let banks take the hit. They benefited from low interest for long-enough.

In short: For the immediate future, I won’t be shorting homebuilders. Too risky while all this cheap money is flowing. But I’ll be watching them, especially MHO, KBH, and MTH.

Disclosure: No positions in any companies mentioned
Disclaimer: None of this information should be treated as investment advice. Always consult a professional.