FHA Capital Cushion Dwindling.

WSJ story HERE says audit shows 39% decline in economic value of FHA insurance fund in last year. Excerpts from Google News Search of this story are pasted below.

"The latest annual audit of the Federal Housing Administration shows a steep drop in the capital cushion the U.S. agency holds against losses from mortgage defaults.

As lenders shy away from risk, the number of loans insured by the agency has soared in recent months, fueling concerns it may be taking on too much risk.

The audit, prepared by Integrated Financial Engineering Inc. of Rockville, Md., estimated the economic value of the FHA's insurance fund was $12.9 billion as of Sept. 30, down 39% from a year earlier.

The FHA insures lenders against defaults on home mortgages that meet standards set by the agency. The drop in the economic value of the fund largely reflects estimates of how falling home prices and growing losses on the sale of foreclosed homes will increase claims paid by the FHA. To calculate the economic value of the fund, the auditors make assumptions about future cash flows and adjust the fund's assets accordingly.

The estimated value of the fund as of Sept. 30 worked out to 3% of total loans insured by the FHA, down from 6.4% a year ago. Federal law requires the ratio be at least 2%. If the FHA runs short of money to pay claims, Congress would have to provide taxpayer funds to make up the difference.

The share of new mortgages insured by the FHA jumped to 26% in this year's third quarter, from just 3% for the full year of 2007, according to Inside Mortgage Finance, a trade publication. Now that the subprime market has collapsed, the FHA is shouldering most of the risk on loans to people who can't afford more than a small down payment.

The audit's assumptions about house prices are based on July forecasts by Global Insight Inc., a research firm. Since July, the housing market has continued to deteriorate. Thomas Lawler, an independent housing economist based in Leesburg, Va., said he sees a risk that losses on FHA loans will be large enough to require Congress to replenish the reserves.

Stephen O'Halloran, an FHA spokesman, said the insurance fund "remains on solid ground."

Effective Oct. 1, the FHA raised the up-front premiums charged to most borrowers to 1.75% of the loan amount from 1.5%. The annual premiums paid by borrowers are 0.5% to 0.55% of the loan balance."