President Obama in his State of the Union address proposed that legislation be passed authorizing FHA to provide all homeowners that are current on their mortgage the opportunity to refinance at today’s record low rates.
“I’m sending this Congress a plan that gives every responsible homeowner the chance to save about $3,000 a year on their mortgage, by refinancing at historically low interest rates,” Mr. Obama said Tuesday night in his State of the Union address.
Since “responsible homeowner” presumably means borrowers that are current on their mortgage, this would be a major program expansion. CoreLogic, a company that tracks 85 percent of all mortgages, estimates that 28 million homeowners could cut the interest rates on their loans by more than one percentage point if they could refinance.
Past attempts to launch mega-fixes have been viewed as failures.
Both the Obama and Bush administrations have struggled with various initiatives designed to help at-risk borrowers to refinance without putting new costs on taxpayers…. After rolling out a series of ambitious loan-modification programs in 2009 that fell short of their goals, the White House largely shied away from more housing policies over the past two years.
This proposal is fraught with problems. Here are five that come immediately to mind:
1. First and foremost, as with so many of the earlier proposals, it does not address the twin problems preventing a housing recovery: jobs and deleverage.
For 3 ½ years we have been using mortgage refinances as a “cheap” stimulus. With apologies to Winston Churchill, for a nation to try to modify itself into prosperity is like a man standing in a bucket and trying to lift himself up by the handle.
The economic stimulus that results from modification is highly questionable. The refinance process is largely a zero sum game. Someone is currently receiving income on these mortgages or mortgage backed securities, which income is lost upon refinance. This greatly reduces the stimulus value of the program.
Instead, the focus must be on permanent private sector jobs. It is jobs that create demand for housing, not the other way around. Creating one million new jobs would add $100 billion to the GDP annually.¹ Modifying 10 million loans would reduce payments by $30 billion per year,² but most of this is income redistribution. Better to have a laser focus on creating 1 million new jobs.
A core problem facing the mortgage market is over leverage—exemplified by the large number of mortgages that are underwater by 20 percent or more. Little has been done in the last 4 ½ years to address this issue. I propose a solution below to accomplish targeted deleverage.
2. Such a mass refinancing could once again roil the mortgage finance market, penalize savers, further delay the return of private capital, and create further uncertainty as to prepayment expectations. This could lead to reduced demand resulting in higher housing finance costs in the future.
3. As I recently pointed out, a new bubble may be growing in 30-year fixed-rate mortgage-backed securities. Domestic governmental units at all levels and their agencies, along with banks and other financial institutions backed by the Federal Deposit Insurance Corporation, now hold 52 percent of outstanding agency securities. The vast majority are backed by 30-year fixed-rate mortgages.
Federal policy has, in effect, created a closed system whereby the government subsidizes the rate on 30-year mortgages, guarantees the credit risk, and then puts itself on the hook for most of the interest-rate risk. Although government protects holders from credit or default risk, these investors are exposed to potentially sizable losses due to changes in the price of the security if interest rates go up. This increases the chances for a bubble in mortgage backed securities largely backed by 30 year fixed rate mortgages.
By creating even more of these artificially low interest rate securities, the impact of any dramatic increase in interest rates in the future will be magnified.
4. Using the financially and administratively challenged FHA as the insurer for such a program will both inundate the FHA and detract from the real and pressing reform FHA needs to undertake now to protect taxpayers, the families unknowingly getting risky FHA loans, and the neighborhoods impacted by FHA’s risky lending.
5. The eligibility pool for this program swamps the HAMP and HARP initiatives. While billed as “[n]o more red tape,” none of the prior programs have met this test. This could bring the mortgage finance industry to a standstill—including new home purchase originations.
So what should be done, besides getting serious about undertaking policies promoting the creation of real jobs? Here are two ideas, one by Lew Ranieri and one of my own. Neither has big downside risks, requires massive bureaucracies, or presents moral hazard risks:
1. As reported by Nick Timiraos in the Wall Street Journal earlier this week:
Local investors could play a greater role in spurring a recovery in their own communities. Some mom-and-pop investors have begun to buy up excess housing stock and rent it out.
These buyers are important to clear the large “shadow supply” of foreclosures. Banks owned around 440,000 homes at the end of October, but an additional 1.9 million loans were in some stage of foreclosure, according to Barclays Capital.
While there’s no shortage of investor demand in many markets, financing remains an obstacle. In 2008, Fannie Mae and Freddie Mac, the main funders of mortgages, faced soaring losses from speculators and reduced to four from 10 the number of loans they would guarantee to any one owner. Fannie now backs as many as 10 loans, but some banks have kept lower limits.
“If that number were raised…to 25, you would very quickly start whittling down this very big backlog,” said Lewis Ranieri, the mortgage-bond pioneer, in a speech last fall. He said loans should be made on conservative terms that include 30% or 35% down payments.
In my view, Lew’s proposal has the right balance of credit risk mitigation and reliance on mom-and-pop investors.
The need to focus on small investors rather than a Washington-centric big investor approach was reinforced by recent research by Tom Lawler:
Contrary to what some espousers of ‘bulk’ REO sales to large investors to rent our SF properties might suggest, the number and percent of single-family detached homes occupied by renters increased significantly during the latter half of last decade, with the largest gains coming in “bubbly” areas. The table below is based on data from the American Community Survey. The 2000 data are from Census 2000, while the 2006-07 and 2008-09 averages are derived from the 5-year, 3-year, and 1-year ACS results for the 2006-10, 2008-10, and 2010 periods released this year.
It is not clear why folks focusing on the rental market for SF housing have not actually looked at any data, much less analyzed or commented on the truly astounding increase in the rental share of the SF housing market in many parts of the country. The astounding increase in the number of foreclosed SF detached homes in Maricopa County occurred, of course, without any mandated program to have bulk sales of REO at discounts to “large” investors.
2. Provide non-delinquent homeowners with severely underwater loans (greater than or equal to a 120 percent combined LTV today) that were guaranteed by Fannie or Freddie prior to their conservatorship a modification down to today’s rate (from an average of 6.1 percent to, say, 3.5 percent), but without any payment reduction (remember these borrowers have been paying for an average of 5 years). This would accomplish the goal of rapid deleverage as the loan would now pay off in 15-18 years. This presents little or no moral hazard and could be done rapidly on a mass basis with little or no borrower fees. It would reduce the losses sustained by Fannie and Freddie (i.e., the taxpayers). Fannie and Freddie would buy the to be modified loans out of the MBS pool at par. This is fair to the bond holders because these withdrawn loans are in MBS that benefited from the direct taxpayer bailout of Fannie and Freddie, a bailout that was not legally required.
1. Assumes $100,000 in additional GDP per job.
2. 10 million times $3000 per modified loan figure used by President Obama.