Former subprime masterminds are back in action, but now they're targeting FHA loans.

In the 1986 film The Color of Money, Fast Eddie Felson makes a return to the pool circuit after teaching his protege Vincent how to hustle money. The lords of the subprime lending world appear to be taking a cue from Fast Eddie's resilience-after fighting off bankruptcies, federal violations, and even felony convictions, some of them are resurfacing as licensed FHA mortgage lenders.

You can call them subprime lords, bad mortgage brokers or, simply, con artists. They're the masterminds behind mortgage firms that targeted bad-credit borrowers and sold them risky, high-priced loans. These entrepreneurs have been slapped around by regulators for employing unlicensed brokers, duping borrowers, producing excessively high default rates, and other mortgage-related infractions. When the subprime market went under, they shut down their lending operations and laid low. But now they've returned. And this time, they have government backing.

New target: FHA-insured mortgages

In the wake of the mortgage crisis, the Bush Administration has put more muscle into the FHA, in the hopes that the agency can step in and provide a better product to borrowers who were previously served by the subprime market. But, according to Business Week, several former subprime lenders are eyeballing the expanded FHA program as a new place to establish themselves. These new FHA specialists include names previously associated with scandalous subprime shops, such as Premier Mortgage Funding, First Magnus Financial, Nationstar Mortgage, and Lend America.

Premier Mortgage Funding and First Magnus Financial have redefined themselves as Paramount Mortgage Funding and Stonewater Mortgage, respectively. Nationstar and Lend America have kept their original names. All four companies are now licensed to originate FHA mortgages.

FHA meltdown may be next

The Business Week article references two sources that predict a massive FHA mortgage meltdown in the next year-Inside Mortgage Finance and Risk Mitigation Group. These are ominous predictions, given that the FHA's activity has ramped up significantly in recent months. In the fiscal year ended September 30, 2008, FHA mortgage approvals rose 125 percent from the prior fiscal year. And the trend continued in October, when FHA approvals rose 12 percent relative to the prior month.

FHA mortgages provide insurance to the lender as a protection against borrower defaults. If unethical brokers push through FHA-backed loans for unqualified borrowers, the federal government ultimately may get stuck with the price tag. In June of this year, the FHA reported higher-than-expected borrower defaults-to the tune of $4.6 billion. To cover those losses, the agency had to pull money from its capital reserve fund. Should this fund go dry, the FHA would presumably have to ask the feds for a bailout.

You can almost picture those former subprime guys looking in the mirror and imitating Fast Eddie Felson's last line in The Color of Money: "I'm back." Let's hope that the FHA wises up to the gig before too much damage by these mortgage hustlers is done.

Published on December 22, 2008