THE BLOG
12/07/2009 06:39 pm ET Updated May 25, 2011

The Next Shoe to Drop in Residential Lending: FHA?

With 7 million properties currently either vacant or in foreclosure, the country cannot afford more residential lending mistakes. Caution: former subprime lending superstars have re-emerged as FHA (Federal Housing Adminstration-under HUD) lenders! This development is a major problem for the country.

I've learned loan officers who previously worked for sub prime loan companies have learned they can work for mortgage brokers and bankers who originate and sell mortgage loans to the federally insured FHA. The FHA was created decades ago to assist lower income individuals purchase homes with lower down payments, more relaxed credit guidelines and easier to qualify loan to income guidelines. FHA has helped many deserving Americans purchase homes. They insured the mortgages creating liquidity for the lending sector so they would not have to carry those mortgages on their books. The system has traditionally worked well due to both the integrity of the originating lenders and adequate oversight by FHA staff of the product being insured.

So what went wrong? Since the shady subprime mortgage lenders of the past were put out of business, many discovered they can work for a company that originates and sells FHA insured loans into the market where there are many buyers since the government insures these mortgages through FHA. The problem is FHA has been unable to properly oversee the huge volumes of loans they have insured since the subprime bubble burst!

Many lenders have delegated underwriting status with FHA and as such are able to approve loans themselves! They are supposed to be following FHA guidelines, therein lies the rub. FHA is unable to properly audit and review the huge surge in loan volume. As a result, opportunistic lenders have made FHA the new dumping ground for loans they cannot sell anywhere else as today's buyers of residential loans are very strict about the quality of the loans they are buying.

Subprime loans were previously sold through various channels through Wall Street entities. Since this channel is closed, opportunists are looking for another way to make money for themselves and put people into homes they cannot afford or are not ready to purchase.

FHA in the past few months began a new QC project to better control the quality of loans they are insuring. But, is it too little, too late? FHA has originated billions of dollars in loans over the past years since subprime mortgages stopped being originated.

Most of the countries banks did not make subprime loans, only 6% of the lending industry made them (and some were not banks, but mortgage brokers). The tiny minority obviously caused a disastrous result for the entire banking sector as the number of delinquencies, vacancies and foreclosures skyrocketed depressing properties values nationwide and thereby straining the entire mortgage finance system. Many in the residential lending industry (including me as the CEO of $1.3 billion community bank originating over a billion a year in conforming mortgages) were stunned the subprime lenders could actually find buyers for their products for nearly a dozen years. The bottom ultimately dropped out of the market.

However, in retrospect, we should have demanded the regulatory agencies take a closer look at this type of lending. Instead, we stood by, allowed the free market to function and are now suffering with deflated real estate portfolios.

I don't think many of us knew what type of effect 'liar's loans' and disreputable lenders could have on the industry and economy. It is in this spirit that I am writing to send a warning signal to the government! We cannot afford another housing black eye. We must protect FHA for the important institution that it is and not allow lenders to take advantage of the system by enriching themselves making loans to individuals who are not able to pay them back.

Note: William A. Donius was appointed to a two year term to the U.S. Federal Reserve's TIAC Council in 2008. He was invited to speak at the Federal Home Loan Bank of Des Moines Symposium on the Future of Residential Finance last month in St. Paul, Minn. He spoke at the educational sessions for bank board members at the invitation of banking regulator, Office of Thrift Supervision during the spring and summer. He is currently writing a non fiction book.

Donius served as the Chairman and CEO of Pulaski Bank in St. Louis until May 2009 and May 2008 respectively. He is a former board member of America's Community Bankers and the Missouri Bankers Association. He currently serves on a dozen boards and committees in the St. Louis area.