Monday, October 12, 2009

Subprime Crisis #2 Coming Soon

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

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It constantly amazes me that the people running the government and reporters who cover the government seem incapable of doing arithmetic at the first grade level. This is usually all that is necessary to foresee a disastrous outcome in the future. This is certainly the case with the impending FHA (Federal Housing Administration) crisis which will be blowing up soon. The FHA insures mortgages that have less than a 20% down payment. It is currently insuring four times as many mortgages daily as it did in 2006 at the height of the last subprime crisis and has 5.4 million loans on its books. A prominent congresswomen recently stated, "without the FHA there would be no mortgage market" right now.

In congressional testimony the head of this government agency recently stated that the FHA's finances were sound. Oh really? The FHA claims to have $30 billion in cash reserves. How long will that last considering that there are $675 billion in loans on the books and 24% of the loans from 2007 are troubled and 20% of the 2008 loans are troubled so far (these numbers can rise). Those percentages could be worse in 2009 and after. If more than 4.4% of the loans insured by the FHA go bad, it could be out of money, assuming (probably foolishly) that the $30 billion they claim in cash is unencumbered. If not, the percentage could be much, much less than 4.4%.

How is it possible that there be even more problem loans on the FHA books from this year and in the future? Anecdotal reports from some areas of the country say that as much as 100% of recent housing purchases are insured by the FHA. All you need to get this insurance is apparently a 3.5% down payment. A spotty employment record doesn't disqualify you, nor does having filed for bankruptcy in the past. Even more eye popping, having a previous mortgage that went into foreclosure does not keep you from getting a new loan insured by the FHA! The FHA business model is roughly equivalent to a company offering $100,000 life insurance policies for $100 to hospital patients who are on life support. Yet, the head of the agency claims that their finances are in good shape.

The FHA is only one of many new bailouts coming. A number of state and local governments are falling deeper into the red. Tax receipts are coming it at even lower levels than anything previously thought possible (another mystery of the 'recovering' economy). Small and midsized banks are falling like dominoes because of their commercial loans going sour. The FDIC insurance fund is already insolvent and the government will have to step in to prop it up. The Credit Crisis is by no means over, we have simply finished phase one and are about to enter phase two. But don't worry, the U.S. government has a printing press and can print all the money necessary to solve these upcoming problems.

NEXT: Dollar Breaks Support ... Again

Daryl Montgomery
Organizer,New York Investing meetup

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

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