As part of the foreclosure-prevention plan announced today by the Obama administration, the federal government will offer to insure the mortgages of some borrowers who are now underwater.
So in addition to the government money going directly into the program, taxpayers could be on the hook for billions more if people who participate in the program go on to default on their loans.
The insurance will come from the Federal Housing Administration, which some observers have said may need a taxpayer bailout. The program announced today could make that possibility more likely.
The loans the FHA would insure under this program would be "exceptionally risky," Paul Willen, an economist at the Boston Fed, told me. The loans will only be the ones where the lender has decided that the borrower is likely to default unless there's a modification. "That's not a great sign about the borrower," Willen said.
The FHA already insures hundreds of billions of dollars worth of mortgages, and the value of loans it insures has risen rapidly in the past few years. It charges borrowers insurance premiums, which allows it to pay claims when people default. But its financial cushion has been deteriorating.
An audit of the FHA released last November found that the agency's reserves had fallen to 0.53% of its total portfolio — well below the 2% minimum mandated by Congress.
The head of the FHA recently testified to Congress that an independent actuary "concluded that FHA's reserves will remain positive under all but the most catastrophic economic scenarios."
But a paper a group of economists published earlier this month suggested that the FHA may be underestimating the risks that could lead to a government bailout.
The bottom line, Willen said, is that the FHA will be in trouble if there's another significant decline in home prices. "What we should have learned form this crisis is we should be prepared for very bad outcomes," he said.