Claims, Subsidies and Forecasts – Oh My!

As you all no doubt have noticed, the $798 million FY 2010 HUD subsidy request for the HECM program is the story that won’t (and shouldn’t) die.  We just read another interesting article over at Reverse Mortgage Daily and since we don’t mind stirring the pot a bit occassionally, thought we’d chime in.

The article focuses primarily on the foreclosures HUD is experiencing on HECMs written in California, Florida, and other particularly hard hit corners of the national real estate market.  While the article is a bit short on hard numbers (How many foreclosures?  How big a loss for the HECM insurance fund?) and only indirectly refers to topics of interest like the $798 million subsidy request (still working its way through the political machine) and default/foreclosure policies for HECM (will HUD start enforcing T&I defaults through foreclosure), it brings up another interesting opportunity.

We’ve stated here before that the FY 2010 HECM subsidy request has nothing to do with HECMs endorsed in prior years, but it bears repeating given that this was one of the first questions in the article comments.

Why Actuals Aren’t As Important As Forecasts

We and others have been passionate (as much as you can be about accounting) about seeing a full audit of actual claim experience on the HECM program, but it’s important to also understand that this isn’t a silver bullet to the current subsidy challenges.

While FHA does periodically publish some information about their actual claims activity (including a great presentation that we’ve reposted here for ease of reference), let’s keep in mind three big challenges when dealing with this data, even if they did publish everything that happened thus far:

1) There are still loans active from very early years of the program, including 1990.

2) Until all loans are resolved for a few high volume years, we won’t have a satisfying ‘actuals’ answer as we’ll always have to rely on projections -the industry didn’t generate enough volume to be statistically reliable until much more recently and it takes 20+ years to have all the loans resolve.

3) Even if we had a high volume year fully resolved to rely on, it isn’t likely to provide nearly the satisfaction that we might expect simply because the one thing everyone can be sure of is that home price changes in the future won’t mirror the past.

So at the end of the day this is always going to be a forecasting exercise no matter what we do, and while we can feel more comfortable with more data/experience to rely upon, we’re just going to have to get used to being wrong when we try to predict the future.

Forecast Errors Are Inevitable, Tolerance Is Not

The real question seems to be what level of tolerance do we have for the potential magnitude of our errors in forecasting, plus or minus, in any given year? Given the political process/environment and the fact that the program is now in a government insurance fund that requires annualized accounting rather than blending the plus/minus forecasting errors over several years to achieve a longer term net number like most private insurance companies, the tolerance seems to be much lower at the same time the political process is directly affecting the most important inputs to the forecasting process.

The sooner we as an industry can get comfortable with managing some of these risks together with our key stakeholders in the political and regulatory process, the better.