Even as the government tries to clean up after the housing excesses of the past few years, The Wall Street Journal opines (subscription required) that it's also sowing the seeds of a new housing bust with Federal Housing Administration loans.

FHA loans are federally insured mortgages made available to first-time home buyers. They require down payments as low as 3.5% (but it's really less because closing costs can be rolled in) and a credit score of just 620 -- far below the 700+ required by most private lenders right now.

As the subprime market has completely dried up, marginal home buyers are returning to the FHA, leading to a huge increase in FHA loan volume. Nearly a third of mortgages are FHA loans, up from just 2% in 2006.

Fannie and Freddie have already gotten their bailouts, and now the third leg of the federal government's affordable home ownership fetish might need more money too: the Federal Housing Administration.

The FHA insures loans for first-time homebuyers, and its obligations could be staggering. The FHA insures loans with down payments as low 3.5%, but given the number of buyers who have wrapped closing costs into their mortgages in recent years, the true loan-to-value ratios may have been even higher.

Some 10.2% of people who took out FHA loans in first quarter of 2008 missed two consecutive monthly payments within the first ten months. And 12.3% of the loans made in 2007 were seriously delinquent.

Economist Allen Sinai, founder of Decision Economics, Friday underscored a dimension of the financial crisis that appears to be getting short-shrift: namely, that U.S. home foreclosures continue to erode the asset base of the U.S. financial system.

Efforts by the Fed, ECB and other major central banks to keep credit markets supplied with dollars, as well as bank recapitalization efforts, are critical to ending the financial crisis, but they won't achieve their goal if more is not done to get at the root cause of the crisis: mortgage foreclosures, economists generally agree.

As Sinai and BloggingStocks' Peter Cohan have noted, home foreclosures are the source of the bad bond problem -- at once both turning selected mortgage backed securities to notes barely worth the paper they're printed on and also weakening banks' balance sheets.

FHA, others must move 'at full-speed on refinances'

Further, economist Richard Felson said it's time for federal officials, in the Federal Housing Authority, Fannie Mae (NYSE: FNM), and Freddie Mac (NYSE: FRE) to "move at full-speed and get as many at-risk mortgages refinanced at lower, fixed rates."

With the U.S. Senate expected to debate and vote on a revised bailout/rescue bill in the next day or so (famous last words), two revisions the world's greatest deliberative body should incorporate are bank recapitalization options and funding to refinance mortgages, economists say.

BloggingStocks' Peter Cohan has written extensively on the need to recapitalize banks, and economist Richard Felson concurs. However, Felson argued that the revised rescue bill should give banks and other institutions the option of either offering their distressed/bad debts to the U.S. Treasury in its reverse auction or accepting a mutually agreeable investment by the U.S. Treasury into the institution.

Creating options for stressed banks

"This will give banks more options, and in my view more incentives to participate in the rescue plan. If the plan just contains asset purchase provisions some banks may balk at the prospect of selling some assets at a fire-sale price of 10 cents or 15 cents on the dollar, and that may prevent some distressed assets from being removed from the system, delaying the financial system's recovery," Felson said. "Offering to buy a stake in the bank offers another recapitalization option."

Few economists / analysts would deny that the financial crisis is so complex, with numerous casual factors, that there's more than enough blame to go around: no one party can or should be seen as 'the culprit.' Moreover, what's paramount now is to identify what works, i.e. what helps solve the crisis, and implement it.

The U.S. Congress' bailout / rescue bill (pdf) is one tool: it will help. If it goes reasonably according to plan, the U.S. Treasury, and the companion agencies the rescue creates, will slowly remove distressed / bad assets from the financial system and in the process would both stabilize the credit markets, and equally important, restore confidence in the financial system.

Another tool: mortgage help in the form of refinanced mortgages for homeowners having trouble paying their mortgage / nearing default.

Economist David H. Wang said Congressional Democrats were unsuccessful in their effort to get U.S. bankruptcy laws amended so that judges could adjust the terms of mortgages -- Congressional Republicans were adamantly opposed to it -- but the bailout / rescue package does authorize the U.S. Government to further assist homeowners who face mortgage defaults.

If you think that the 'too big to fail' / 'too interconnected to fail' doctrine probably protects the Bank of America and JP Morgan Chase, you think right. But don't expect either stock to race-up like Microsoft (NASDAQ: MSFT) did in the 'Wonderful 1990s' -- not just yet.

The U.S. Government's estimated $700 billion plan to stabilize credit markets will likely safeguard both BAC and JPM due to the large impact a failure of each would have on the financial system, Luigi Zingales, professor of finance at the University of Chicago, told Bloomberg News Monday, adding that it "will definitely make their bonds safer."

BAC, JPM: Operational challenges ahead

However, economist Richard Felson told BloggingStocks Monday investors should not rush out and buy either stock just yet. Felson added that he does not have a rating on nor own shares in either company. The Bank of America (NYSE: BAC), which closed Friday at $37.48, has a p/e of 21; JP Morgan Chase (NYSE: JPM), at $47.05, a p/e of 15.5.

"Each has a series of operational issues to address in the financial services space," Felson said. "The Bank of America has a major merger and culture integration process ahead following the purchase of Merrill Lynch. Major employee, client retention and investment decisions are ahead, and this will weigh on shares."

The U.S. Government's decision Friday to put in place a sweeping program to buy distressed/bad debt to stabilize the financial markets will likely represent the biggest intervention of the federal government into the private sector since The Great Depression of the 1930s. But not everyone is convinced the action is destined to add hundreds of billions to the taxpayer's bill.

U.S. Rep. Barney Frank, D-Massachusetts, is chairman of one committee that will review the U.S. Treasury's/U.S. Federal Reserve's plan, the House Financial Services Committee. He believes the plan will cost taxpayers "ultimately not a great deal. The Treasury will buy selectively," Bloomberg News reported Friday.

Frank added that the bad debt will cost "maybe double-figure billions over a few years. The government will sell the assets back," he said, Bloomberg News reported.

Frank's forecast realistic or optimistic?

Is U.S. Rep. Frank's cost estimate realistic or very optimistic? Economist David H. Wang told BloggingStocks Friday that depends on several factors.

"On the one hand, if we have a two-year period of economic stagnation, the government could end up with hundreds of billions of dollars of extremely-low-grade bonds, bonds that they may only be able to recoup the equivalent of 20 cents or 10 cents on the dollar," Wang said. "Some bonds would be written-off, others reconfigured and perhaps grouped with other investments, with the housing that backs them perhaps converted to other uses."

"On the other hand, if the government intervention broadens the conforming loan category of both Fannie Mae and Freddie Mac, as the legislation is expected to do, this will enable more 'somewhat-risky' mortgage bonds to be purchased, providing even more liquidity," Wang said. "And if the FHA [Federal Housing Administration] also receives more money to refinance mortgages at a lower rate, this will help check the high level of foreclosures."

"Under the latter scenario, net government outlays would be considerably less," Wang said. "Essentially, the issue is this: can the government maintain financial market liquidity, ease risky bonds out of the system, and reduce foreclosures with this plan? Not a simple task, but it is possible, over years."

The head of the Senate Banking Committee has indicated that the U.S. Federal Reserve has the authority to create a new 'debt fund' to buy, warehouse and dispose of distressed / bad debt resulting from the subprime mortgage crisis.

"The Fed has the authority to move in this area," U.S. Sen. Chris Dodd, D-Connecticut and chairman of the committee, told Bloomberg News.

Many economists and analysts argue that a step integral to stemming the cycle of foreclosure / housing price decline / bad bonds / stock run / collateral call / bankruptcy is for a special agency to buy up and strategically restructure, then sell, distressed / bad assets. Economist Peter Dawson is one of those economists who favors the tool.

"Ideally, you'd like to have a private-sector consortium of banks or other financial institutions to coordinate the effort, but right now there aren't exactly a lot of banks stepping up to the plate to take a swing," Dawson told BloggingStocks Thursday. "There's a considerable amount of fear in the market, frankly, and banks are hoarding cash. If this remains the case then we'll need a public sector effort to put this new institution in place."

Homeowners struggling to pay their bills must find the federal government's bailout of troubled Wall Street firms confusing.

After all, government officials have repeatedly said they would not help victims of the subprime mortgage crisis, reasoning that they should not get rewarded for making bad decisions.

It's Economics 101 that people who take bad risks will continue to do so if there are no consequences to their actions. But the $85 billion rescue of American International Group Inc. (NYSE: AIG), the bailout of Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE), the possible rescue of Washington Mutual Inc. (NYSE: WM) and the shotgun wedding of Merrill Lynch & Co. (NYSE: MER) to Bank of America (NYSE: BAC) brings all of these cherished notions of free markets into question.

Why is the government helping companies who sold mortgages to people who they knew couldn't afford them and repackaged the loans into securities that were unloaded on unsuspecting investors -- but doing little for individual homeowners?

Economists differ regarding whether the U.S. economy has officially fallen into a recession, but for investor Mario Gabelli, the debate is the esoteric stuff of academicians and analysts.

Gabelli has his own reading on the U.S. economy and he isn't opaque about it.

"The consumer has been in a recession since November 2007," Gabelli told Bloomberg News Friday. "The economy has been bolstered by exports and a few other things."

Further, Gabelli, who oversees $28.3 billion as chief executive officer of Gamco Investors, Inc., said the U.S. Congress may have to boost the economy with additional tax rebates, Bloomberg News reported Friday. Congress passed and President Bush signed a $117 billion tax rebate package earlier this year.

Gabelli's comments occurred before the U.S. Labor Department announced Friday that the U.S. economy lost another 84,000 jobs in August, with the unemployment rate rising to 6.1% -- a 5-year high. The U.S. economy has now lost 605,000 jobs in 2008 after creating just 1.1 million in 2007.

Gabelli says takeover of Fannie, Freddie needed

Further, Gabelli said the federal government must take over Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE), the U.S.'s largest mortgage financiers, as a prerequisite for housing sector recovery, Bloomberg News reported.

TheStreet.com's Jim Cramer says they should be punished for trying an end run on taxpayers.

Love Centex (NYSE: CTX) (Cramer's Take), sell Horton (NYSE: DHI) (Cramer's Take)? That's how I feel after reading Horton's pathetic plea to bring back down-payment assistance for this industry, which remains unpunished for all it did to foment the housing crisis.

Yesterday, in one of our "Wall Street Confidential" series, I opined that Centex was shaping up to be one of the better builders after making so many right moves in the last year to preserve capital. I didn't care for industry leader D.R. Horton, though.

And that was before I read the outrageous comments from Horton CEO Don Tomnitz in Market Watch yesterday, where he decried that the new housing law didn't include more down-payment assistance loans from the FHA. These seller assistance loans plied basically, by the homebuilders that allow homebuyers to use a back door to FHA loans, have been defaulting at very high rates. The Congress, in an actual dollop of wisdom, scrapped them and instead gave people a tax credit of $7,500 to buy a new house, not bad considering that houses have retreated in value to the point that even though you need to put down more money as a percentage basis, as an absolute basis there's some affordability. This kind of loan is precisely what got us in trouble, an affordable loan that people ultimately couldn't afford that just helped Horton dump properties.

The Associated Press reports that the House passed a bill that will increase the amount of debt available to buy houses. In the process, it will make the U.S. a much riskier place to invest. That's because when a country's debt tops 60% of its Gross Domestic Product (GDP), lenders consider it a risky credit. The House bill will lift the U.S.'s ratio to 75%. And the dollar will continue to plummet.

Of course, the bill is not being sold that way. Instead its stated goals are to help 400,000 people with foreclosures and to save Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE). Here are six key provisions according to AP:

• Puts distressed real estate on the government's books - Provides $3.9 billion in grants for "devastated neighborhoods" -- a provision the White House hated since it looked like the S&L bailout's RTC, that Bush I approved.
• Gives Paulson unlimited Fannie/Freddie bailout power - Gives the Treasury Department an unlimited line of credit to bail out Fannie and Freddie and to buy an unspecified amount of their stock.
• Creates new debt for drowning borrowers - Lets 400,000 foreclosing homeowners refinance into more affordable, fixed-rate loans backed by the Federal Housing Administration (FHA).

U.S. Rep. Barney Frank, D-Massachusetts and Chairman of the House Financial Services Committee, Thursday introduced legislation to enable the Federal Housing Administration to insure and guarantee mortgages that have been written down banks and other mortgage holders, Rep. Frank announced in a statement.

Rep. Frank's proposal would permit the FHA to provide up to $300 billion in loan guarantees which could potentially result in the refinance of 1-2 million at-risk mortgages, preventing foreclosures, "protecting neighborhoods and help stabilize the housing market."

MarketWatch has published a story that details the conundrum new first-time home buyers are facing in today's market. In "First-time home buyers struggle to find down-payment money," staff writer Amy Hoak tells about a middle-class family that bought a house a couple of years ago without having to put any money down. This same family, admittedly, would have trouble finding a loan today to finance their purchase.

Typically, when mortgage lending is restricted, it affects first-time owners the most because they frequently lack the funds for a down payment. According to the MarketWatch article, 45% of first-time home buyers opted for 100% financing between July 2006 and June 2007.

Experts are predicting that lenders are going to require more and more down before they're willing to lend to home buyers. To counteract stricter lending practices, check out loans backed by the Federal Housing Administration (FHA). According to MarketWatch, statistics confirm the recent popularity of these loans: The FHA backed 17,773 purchase loans in December 2006; that increased to 24,817 purchase loans in December 2007.

Down payments for these types of loans are around 3% and there are even down-payment-assistance programs to help to this end.

With market prices catering, buying a home in certain localities may prove a good move.

Zack Miller is the managing editor of IsraelNewsletter.com and a former equity analyst for a leading multinational hedge fund.

Groucho Marx once remarked that whenever things start to look really dark, remain calm, don't panic, and above all, turn on a light.

Given the barrage of financial stresses battering the credit and equity markets these days, consumers, economists and investors alike could use some of Groucho's levity, and some light. In this case the light may appear in the form of the Federal Housing Administration.

What's old is suddenly new

The Federal Housing Administration, the once-viewed-as-antiquated, irrelevant Great Depression-era government agency, is suddenly emerging as the centerpiece of government efforts to bolster the U.S. housing market, reported The Wall Street Journal (subscription required.)

The FHA has become the cheapest, and in many cases, the only alternative for borrowers who can make only a small down payment, and the agency is rapidly gaining market share.