Obama’s Homeowner Affordability and Stability Plan: A Band-Aid for the Foreclosure Crisis?
The aim of the homeowner stability plan is to reduce the number of avoidable foreclosures in order to reduce the negative spillovers to entire neighborhoods and break the ensuing negative feedback spiral. The plan is part of the administration’s comprehensive Financial Stability Plan including 1) the Capital Assistance Program for thinly capitalized financial institutions ($150bn remaining TARP funds), 2) a Public-Private Investment Fund to remove toxic assets from banks’ balance sheets (initial private sector commitment leveraged up to $500bn, up to $1 trillion), 3) the TALF lending facility to extend collateralized loans to buyers of newly issued consumer asset-backed securities and securitized commercial loans ($1 trillion, of which $100bn from Treasury and $900bn Fed loans).
In the first part of the Homeowner Affordability and Stability Plan, the Treasury will help refinance conforming loans owned or guaranteed by Freddie and Fannie by targeting current prime homeowners who have positive home equity but are facing declining home values. To reduce monthly payments for such homeowners, the interest rate on the loan will be reduced to 5.16% from 6.5% and the maturity will be extended by three years though the principal balance will be increased. For fairness, those with lower debt/income ratio and higher positive home equity but facing greater decline in home prices will receive more savings in interest payments relative to others. The Treasury’s stated goal is to limit the number of preventable foreclosures in order to mitigate the negative spillover effects on neighborhoods and break the ensuing negative feedback spiral.
However, this helps only homeowners facing ‘temporary’ difficulty in making monthly payments due to falling home prices and short-term liquidity crunch due to the recession while ignoring bigger problems of the current crisis – those with negative equity and who cannot afford to make payments in any scenario. While negative home equity may not lead to outright delinquency or foreclosure, mounting job losses and massive wealth erosion for households even as they see low probability of home appreciation in the immediate term – all these factors will make defaults and foreclosures more likely in the coming months. According to some Fed estimates, if the unemployment rate hits 8% by mid-2009, around 8.4 million homeowners will be unemployed out of which 35% will have negative equity. Moreover, Credit Suisse estimates that over 9 million homes will enter foreclosure in the next four years. Also, the plan excludes subprime, Alt-A, Option ARM and jumbo mortgages though they are most vulnerable to defaults. Importantly, last October the loan limit of Fannie&Freddie conforming mortgages was increased from $417,000 to $729,750 in areas designated as ‘high cost’.
The plan focuses on current prime borrowers, not necessarily a group in need of support at first glance. From RGE’s perspective the focus on prime borrowers with negative equity with an incentive to walk away is supported by the numbers: The latest OCC figures on the industry’s largest mortgage servicers (including 60% of of all mortgages outstanding in the U.S.) show that although the percentages of seriously delinquent loans and foreclosures in the prime category are smaller than in the subprime category, the actual number of affected loans is actually larger among prime borrowers (P 13 and 25)
Refinancing of negative equity mortgages is necessary if prime borrowers are to take advantage of lower mortgage rates induced by direct Fed’s Fannie & Freddie purchases of MBSs to the tune of $500 billion. However, market participants caution that the prime mortgage foreclosures reported by the OCC above are mainly jumbo loans excluded from the refinancing option. Due to fairness considerations and the potential costs involved we see it as unlikely that the administration extends the negative equity refinancing option beyond the conforming limits of $417,000 and $729,750 in areas designated as ‘high cost’.
The following paper tests the home price and delinquency correlation empirically, both for subprime and prime mortgages: Subprime Mortgage Delinquency Rates
Related RGE spotlight issue: Market-Based Approaches For Upside-Down Mortgages: Bernanke’s Principal Balance Reductions And OTS’ Negative Equity Certificates
The second part of the plan targets mortgages owned by private lenders that have negative equity and loan/home value ratio of over 105% along with recent income or job loss. Here the mortgages will be refinanced by reducing the interest rate by a larger amount compared to the first part of the plan while keeping the principal balance and maturity unchanged rather than increasing it so that homeowners end up saving relatively more on the monthly payments. All banks using TARP money will be required to participate in this program and the government will offer several incentives to increase lender participation. First to bring down the monthly payment/income ratio to 38%, the lender will have to cut the interest rate to reduce the monthly mortgage payment – this will be the cost to the lender. Then to bring down this ratio to 31%, the government and lender will work together to further reduce interest payment by bringing down the interest rate further down – here the government will match each dollar of the cost borne by the lender and for this purpose $75 billion from TARP will be used. However, the amount of government subsidy will be far less than the cost that private lenders have to bear, thus reducing lender participation. If the lenders agree to reduce the mortgage principal instead of the interest rate, the government would again contribute to this cost, equivalent to the amount lenders would have received for the interest rate reduction. However, lenders like in the past programs will modify loans via interest rate or maturity changes and keep principal reduction only as the last resort, thereby just delaying the risk of default or foreclosure.
Additionally, to attract lender and mortgage servicer participation, again a shortcoming of previous programs, the government will offer $1000 to servicers for modifying mortgages, and up to $1,000 per year for three years if the homeowner remains current on the modified loan. Government will give $500 for servicers and $1500 for mortgage investors if loans are modified before borrowers fall behind their payments. But again these monetary incentives are too small to attract lender and mortgage servicer participation especially compared to the cost for lenders to reduce the debt/income ratio to 38%. Though lenders and servicers realize that the cost of modifying mortgages will certainly be less than the cost from foreclosures, the fear of lawsuits from investors is constraining them from participating in the mortgage modification programs. Therefore, there is a need to allow bankruptcy courts to modify mortgage terms while giving legal protection to lenders and servicers. While the administration has endorsed this idea, it will require a Congress legislation which is now being debated in both the houses of the Congress and might be a part of the government’s next housing plan.
The Treasury will also create a $10 billion Insurance Fund to provide partial guarantees to lenders if default on modified loans are higher than expected due to decline in home prices. But this falls short of the government guarantees for modified mortgages that is required to increase lender participation by the government sharing losses with the lenders (up to 50% as proposed by some) in the case of default.
This loan modification plan includes incentives for borrowers, lenders, servicers, and mortgage holders including RMBS investors. At RGE we think that this plan is set to produce the best possible results if principal reductions are not an option.
Hence, while the plan improves over the shortcomings of previous programs especially by increasing incentives for lenders, the extent of government action is still inadequate. There are two sets of problems: Homeowners with negative equity and homeowners not being able to make monthly payments due to income and job losses – While the latter’s problem can be coped with refinancing, which the government is targeting, the former group needs principal reduction where the government has been less forthcoming. Using the refinancing option for those with negative equity will only increase the risk of future default. While the government has allocated $275 bn for the current program, much larger amount of funds will be required if principal reduction is carried out (some estimates suggest $600 billion taking into account the expected peak-to-trough home price correction). Moreover, voluntary and case-by-case approach of the program will limit participation by both lenders and homeowners to far less than the 7-9 million homeowners the plan aims to target, just like the participation in past programs has been extremely low. Therefore moving forward, the government needs to adopt an across-the-board mandatory program to reduce the principal for ‘qualifying’ homeowners with negative equity using some parameter (by the extent of home price decline according to zip code as suggested by many is an attractive option) and refinance the loan at a fixed interest rate, with the government sharing this cost with lenders (greater than what is under the current program), and also offering guarantees to share the cost of default or profit from future home appreciation. Also see Nouriel Roubini’s HOME proposal and the HOLC program of the 1930s.
Under the third part of the program, to help Fannie & Freddie increase lending and reduce mortgage rates, the Treasury will increase its Preferred Stock Purchase Agreement in these GSEs to $200 billion from the currently $100 billion (financed by the Housing and Economic Recovery Act) and will continue to purchase MBSs.
Will GSE Fees Be Changed/Waived? We have seen no indication of that and we think it unlikely. Fees were waived for FHA loan refinancing but unlike F&F, those loans are guaranteed by Ginnie Mae, the only GSE with ‘full faith and credit’ of the government. The increased risk of refinancing higher loan-to-value loans will most likely require an increase in the effective guarantee fee rate (latest 2008 report to Congress shows such an increase is already underway [P30]).
How will they get around Mortgage Insurance and how will Mortgage insurance be handled? If it is rolled over, what about the loans that did not have Mortgage insurance?
James Lockhart Interview: Mortgage insurance will be rolled over in case the insurance was in place before but no new insurance will be required in new GSE refinancing plan. Lockhart talks explicitly of recapitalization plans for the PMI industry suggesting that buying insurance from severely undercapitalized institutions that are struggling already with their current exposures is useless. He is confident that the FHFA has enough legal authority to implement the proposed changes without having to go through Congress first.
See Opinions: Bloomberg Audio/Video Report Feb 19, 2009James Lockhart Says Fannie, Freddie Future Depends on Market
See also related RGE spotlight issue with the latest Fitch report: MGIC, Radian Private Mortgage Insurers in Trouble: Another Hampered Business in the Subprime Aftermath?
No Responses to “Obama’s Homeowner Affordability and Stability Plan: A Band-Aid for the Foreclosure Crisis?”
TA • February 27th, 2009 at 11:12 am
“Therefore moving forward, the government needs to adopt an across-the-board mandatory program to reduce the principal…”.I’ve been advocating that position here for some time. There is no other viable solution – none, zero, zip, nada, doughnuts.Make no mistake; a government sponsored plan to reduce “bubble-era mortgage principal” to “post-bubble-era market value” will happen.With that conclusion in mind, topics worthy of further investigation and discussion include how to implement such a solution, who and what’s affected and how, and when should it be implemented?But what if the administration doesn’t have the political will to enact the only viable solution to end both the housing and economic crises? What will the landscape look like in say 1, 3, & 5 years?
Anonymous • February 27th, 2009 at 9:48 pm
I have not read the plan nor this article in detail but was wondering if such a plan will lead to more people missing their payments to qualify for a bailout.i.e. if we did not have such a plan then say person X would have paid his mortgage but now even though he can afford his payments, he would deliberately start missing his payments
Guest • February 27th, 2009 at 9:54 pm
just wondering if you have any plans to do any article on the links between faster immigration (to those who are already in the US) and housing solutions ?or on increased foreclosures due to stricter immigration crackdowns ?
Guest • February 28th, 2009 at 6:58 am
I am not convinced anything you try will change the end game or be fair to people who did not take part in the insanity that got us here,Where was everybody when home values went up like a rocket mostly driven by development of crazy financial instruments to allow more people to buy homes?There will be principle written down whether the government gets involved or not. Somebody will have to take a loss but the problem is not everywhere and it will not spread everywhere. Not everybody is like California, Arizona, Nevada, Michigan and Florida.The landscape in 5 years may be worse with government intervention than with out. It depends on the type of intervention, whether the government fights the market correction or ties to speed up the process.
Dr. Fred in PA • February 28th, 2009 at 8:04 am
No way. If you can’t pay your mortgage, too bad. Citi needs to go bankrupt as do Fannie and Freddie. These people and institutions have FAILED. Failure has consequences. Propping up the corpse only stinks up the room.
Guest • February 28th, 2009 at 4:18 pm
I have an idea – send every taxpayer $20,000 – those who have a mortgage must pay their principle down and those who do not can use the money for what ever purpose they want. I personally understand why that is a stupid idea. Is it any different than what has been taking place so far. Since I and my children are being forced to borrow and pay back the money at least this way I get to spend it. Heck why stop at $20,000 let us go for $80,000.
Jobless • February 28th, 2009 at 7:13 pm
I just lost my job but am (currently) current with my payments. Can I qualify for a refinance?
