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The Federal Housing Administration today tightened credit restrictions to reduce the agency's exposure to risk and announced it was hiring a chief risk officer after the Washington Post reported the agency is rapidly running out of money due to loan losses and its cash reserves are in jeopardy of falling below falling below the minimum level set by Congress.

FHA Scrambles to Control Loan Losses

The Federal Housing Administration today tightened credit restrictions to reduce the agency’s exposure to risk and announced it was hiring a chief risk officer after the Washington Post reported the agency is rapidly running out of money due to loan losses and its cash reserves are in jeopardy of falling below falling below the minimum level set by Congress.

FHA Administrator Dave Stevens said the changes that are largely focused on ensuring responsible lending and risk management for FHA-approved lenders. These changes build on lessons learned in the credit crisis and seek to align the FHA with the Administration’s goal of regulatory reform by ensuring lenders have long-term interest in the performance of the loans they originate, he said.

The Post story said FHA officials feared the agency’s financial reserves could fall below the minimum required level, which currently amounts to two percent of all loans guaranteed by FHA. If so, it could be forced to ask Congress for billions of dollars in emergency aid or charge borrowers more for taking out FHA-insured loans.

Economist Ann Schnare, writing in Real Estate Economy Watch on June 29 (Can FHA Dodge the Bullet?) questioned whether FHA’s reserves could remain above the minimum level and warned readers about the consequences.

“Under relatively conservative assumptions regarding future house price trends and economic conditions, we project that Fund will experience a capital shortfall,” she wrote. “Our conclusion that FHA will not be immune from the market forces currently ravaging the mortgage industry should hardly come as a surprise. In fact, the real question is how the Agency has been able to dodge the bullet thus far. Part of the explanation is that FHA was largely out of the market at the peak of the housing boom. As a result, most FHA borrowers entered the housing downturn with at least some accumulated equity in their homes. In addition, while most FHA borrowers put little money down and have relatively weak credit profiles, FHA mortgages have none of the toxic features characteristic of subprime loans, for example, reduced documentation or teaser rates.

“Our analysis suggests that the forces that have protected the FHA Fund thus far have more or less come to an end. While the projected capital shortfalls at FHA may pale in comparison to the losses at Fannie Mae and Freddie Mac, the prospect that the Fund may fail to meet its mandatory capital requirement by the end of the year is nevertheless troubling. The continued availability of FHA mortgages will be critical to the recovery of the housing market. Without a strong and active FHA presence, millions of prospective borrowers will lose access to mortgage credit,” she concluded.

HUD Secretary Shaun Donovan, by contrast, sounded confident today that hiring a new executive and forcing lenders to assume more of the risk would solve the problem.

“By keeping affordable loans flowing, particularly to the growing ranks of first-time homebuyers, the FHA has been critical to our nation’s economic and housing market recovery. As we begin to move from recession to recovery, these changes will not only ensure FHA’s financial strength but they will also help to further strengthen our nation’s economy,” said Donovan.

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