The President’s latest housing proposal aimed at supporting a housing recovery unfortunately does not offer much real impact on that front.
Instead the proposal is really the latest in a plan to stimulate the economy by offering to put an additional $3,000 per year in the pocket of underwater borrowers who remain current on their mortgage. But even then, the effect of the economic stimulus is muted.
This plan is really a reincarnation of several other initiatives already underway with a few new enhancements. For example, the plan expands on existing refinance programs (HARP and FHA) by allowing borrowers whose loans are with banks to refinance via the FHA. Another aspect of the proposal is to incent Fannie Mae, Freddie Mac and banks to offer principal reductions to distressed borrowers by tripling the subsidy provided to take these writedowns. A third prong of the proposal touts a pilot program to sell REO properties that will be turned into rentals. While interesting policy proposals, they fall well short of helping heal our troubled housing market.
To get a better picture of why this is unlikely to stabilize housing in a material way, consider the following facts. The plan suggests that 3.5 and 11 million potential refinances could be possible from non-GSE mortgages and GSE loans, respectively. So far the results aren’t encouraging, with less than 1 million obtaining a refinance under current programs. Let’s assume the President is right about the annual savings from a refinance being about $3,000. And let’s further assume that the program doubles in size to 2 million more refinances. That’s $6 billion to stimulate the economy – basically an amount that would hardly move the needle on reving up the economy. But there are a number of important impediments standing in the way of even this level of refinancing. First, banks would need to jump on board, and if they hold the loan in portfolio, they are unlikely to give up the income stream from the higher rate loan unless the borrower has a higher likelihood of default down the line. A 750 FICO borrower with little intent to default and paying on a 6.5% mortgage is a good portfolio loan from both a credit and interest rate risk perspective. In that case, the program actually incents lenders to adversely select the FHA all day long by sending them the low creditworthy borrowers (the program allows FICOs down to 580) with the result that FHA winds up taking the loss as a result. Compounding this incentive, the FHA will relax the “compare ratio” used to determine the quality of FHA lenders. With this in place, lenders are free to send along loans that they deem more likely to default and keep those likely to remain current. Now the proposal calls for a separate fund for these new refis to be established – but whether the FHA MMI fund covers the loss or it comes from Treasury – either way the US taxpayer is on the hook for those loans now and not the banks that originated them. In terms of the expansion of the HAMP program to boost incentives for principal reductions, the US taxpayer again is on the hook for these subsidies. A second issue holding back the program is how to address 2nd liens – the proposal doesn’t outline what exact steps would be taken to resolve this issue for 2nd lienholders. Further, the program still requires some Congressional action, and we know what that means in the middle of an election year. So, with all of that, the refi program is likely to have limited overall economic impact, doesn’t really help the problem of weak demand and oversupply, and imposes costs onto the taxpayer. Now the plan does impose a charge onto large banks to cover the costs associated with administering the program, but in the end, banks will find ways to pass this along to their customers, so indirectly we wind up paying for this downstream. A third cost of the refi program is on holders of GNMA and GSE bonds. If loans refinance, it raises prepayment rates on securities that have these mortgages as collateral. That hurts the value of these bonds ultimately which are held due to their relatively low risk by retirees and pension funds, among others. This unintended consequence is something not disclosed in the proposal either.
In the end, the proposal is a disappointment. It is essentially a retread of earlier programs that have not worked or provided any degree of stabilization in housing. The problem is that full disclosure of the economic realities of these programs is not provided. A HUD economic analysis (see link), for example, suggests that the FHA refi program would provide a $53,660 benefit to lenders over a foreclosure for current and underwater borrowers. But the analysis glosses over an important point that for a current borrower the probability of default is nowhere near 100% which is the assumption used. Assuming a more realistic but conservative default rate makes the FHA refi program a net loser to lenders, but that isn’t what the HUD analysis shows.
Digging deeper into the details, one soon finds that rather than being an important new policy weapon to spur housing recovery, it winds up being a political tool that is not helpful to markets. Better that we focus on efforts to boost demand using new mortgage products to eliminate borrower uncertainty, provide investors for financing of bulk REO inventory, the use of shared equity arrangements and creative private-public financing than to dust off programs that have demonstrated little success so far.