For decades the American government sought to increase homeownership because of a belief that it reinforced a faith in capitalism and made better citizens. Unfortunately, this effort turned into government mandates that led the Federal Housing Administration, Fannie Mae and Freddie Mac to provide such excessive support for homeownership, driving up demand and house prices. Then, because many unqualified buyers got mortgages, intended beneficiaries lost their homes and neighborhoods were destroyed. As distressed homeowners and foreclosed properties increased, demand plummeted and prices dropped, exacerbating the problem.

Recently, FHA admitted its reserves for unexpected loan losses would fall short of the congressionally mandated levels of 2 percent. The projected capital losses in 2009 were worse than the most pessimistic assumptions. It is increasingly likely the agency will need to ask Congress for many billions of dollars.

An audit of the FHA released Nov. 12 showed that its capital-reserve fund had fallen to $3.6 billion as of Sept. 30. Reserves are just 0.53 percent of the $685 billion in total loans insured by the FHA. The agency’s potential losses could easily exceed historic levels because the FHA has increased its guarantees in 2009 some $300 billion, nearly doubling the size of its portfolio.

David Stevens, the FHA commissioner, stated on Oct. 8 that FHA’s business written in 2007 and 2008 is expected to suffer 24 percent and 20 percent default claims rates, respectively.

Housing Secretary Shaun Donovon said, “It is absolutely critical that we build the cushion back up.”

FHA, Fannie and Freddie are the source of 95 percent of the United States mortgage financing. The share of FHA mortgages went from 2 percent to more than 25 percent of mortgages in the country. FHA is a major source of funds for first-time home buyers. Many of the riskiest borrowers received financing under FHA programs.

The FHA does not make loans itself, but insures against default. Borrowers are willing to buy the insurance because FHA-backed loans require down payments of only 3.5 percent of the purchase price

Edward Pinto, former chief financial officer of Fannie Mae, an expert on the causes of the mortgage crisis and a housing consultant, issued repeated warnings about these problems. Pinto pointed out that FHA’s foreclosures have increased from 0.15 percent in 1951 to an estimated 4.4 percent in 2009 — a 30-fold increase. Risky FHA financing has now spread to virtually every neighborhood in the U.S.

Pinto projected that FHA might need a taxpayer rescue of possibly as much as $40 billion within two to three years because of the following:

1. Housing prices and foreclosures could approach levels that the FHA provided in their worst-case scenario.

2. The loss from each foreclosure could be greater than FHA estimates.

3. The FHA is suffering from adverse selection, meaning it is exposed to risk because its customers are most in need of mortgage assistance.

Pinto offered several helpful suggestions:

1. Raise the FHA down payment on homeownership to 10 percent so as not to distort the housing market and home prices.

2. Reduce FHA’s dollar limit back to a level commensurate with its low- and moderate-income housing mission.

3. Require FHA lenders to also have skin in the game through a coinsurance requirement of perhaps 10 percent.

Failing to change policies will only increase FHA’s and the taxpayers’ losses.

Originally published in the Sarasota Herald-Tribune