First it was the big banks with their failed "credit-default swap" schemes and subprime mortgage meltdown. Then it was federally-backed mortgage giants Fannie Mae and Freddie Mac who sagged under the weight of risky home loans.
Now the government agency responsible for insuring more than $1 trillion in mortgages could be in financial trouble, with most of its cash reserves depleted and claims on defaulting mortgages mounting.
The Federal Housing Administration will likely need a bailout next year if housing market conditions don't improve, according to a recent report by the agency's independent auditor, leaving taxpayers on the hook for still more housing market failures. Some have estimated the FHA could need as much as $100 billion from Congress to shore up its balance sheets.
"We're going to have to recapitalize these guys, and it's just a question if you want it to get worse before you stabilize it," says Joseph Gyourko, professor at the Wharton School of the University of Pennsylvania. "They need at least $50 billion." Depending on how much the government wants to pad the FHA's cushion for loss, that sum could be as high as $100 billion, Gyourko says.
The FHA doesn't originate loans but insures private lenders against homeowner's defaulting on their mortgages. The agency, which used to back just 5 percent of loans, mostly for first-time homebuyers, now gobbles up nearly 30 percent of the market.
The FHA's current financial straits stem from an increasing number of loans defaulting due to the housing crisis—the agency has already paid out a record $37 billion in claims over the past three years, effectively whittling away the agency's already undersized cushion for loss. It will likely face more claims as the housing market continues to languish.
The agency's capital reserves, which provide funds to absorb homeowner defaults, are alarmingly low according to some observers. Estimated reserves stood at about $3 billion in September, according to the auditor's report, down from nearly $5 billion last year. Reserves have been below the legally mandated level since 2008, and won't exceed that threshold until 2014 according to the report.
That prediction is based on the hope that home prices will bottom out sometime in 2012 and then begin to recover. But that doesn't mesh with forecasts from many economists who say prices will continue to fall another 5 percent potentially not bottoming out until 2013.
Despite the gloomy predictions of economists and auditors for the housing market in 2012, FHA officials argue that the agency won't need a taxpayer bailout.
"It would take very significant home price declines to create a situation in which the portfolio would require any additional support," acting FHA commissioner Carol Galante told the New York Times.
But given the volatile nature of financial markets and the fragile recoveries in both the housing market and the broader economy, it wouldn't take much to tip the FHA over the edge. According to the auditor's report, significant declines of home prices in 2012 could put enormous pressure on the agency's cash reserves.
One estimate puts FHA's reserves at a paltry $1 billion should housing prices tank.
"That's their cushion for unexpected losses," Gyourko says, underscoring that FHA currently has a portfolio amounting to more than $1 trillion in single-family mortgage insurance. "So basically, they have no cushion."
"What FHA did was lever up," Gyourko says. "They increased their insurance guarantee portfolio almost four times. They've increased their capital by almost nothing."
But while FHA's projections might be too rosy, Gyourko's might be too bleak, some say. Even Gyourko himself concedes there is little reason to expect an extreme crisis for FHA in the next year or so. "That would take a huge leap in defaults and almost immediate losses that no one is anticipating," he wrote in his working paper "Is FHA the Next Housing Bailout?"
The truth is probably somewhere in the middle, most experts say. While FHA might be severely undercapitalized for the size of its liabilities, the losses the agency would have to sustain to go under would be massive.
"Yes, there is such a scenario, but frankly for that to happen the market would have to crash so badly, we would have other things to worry about than bailing out the FHA," says Tom Geurts, visiting associate professor of real estate and finance at the George Washington University in Washington, D.C. "[Gyourko] is right, but the scenario he paints is too bleak."