The Obama Administration is planning to launch yet another mortgage refi program, this one targeting subprime borrowers who are current on their loans but underwater, extending the government support of the mortgage market to yet another borrower group. The timing raises the question of why this initiative is under consideration now, as opposed to earlier, since it’s hardly news that a lot of homeowners are still in negative equity territory (10.8 million now, according to the Wall Street Journal’s Nick Timiraos, down from 12.1 million thanks to the recovery in housing prices).
It appears that the Administration isn’t convinced that further home price appreciation will restore these borrowers to having equity in their homes any time soon. And perhaps even more important, this program is seen as a way to boost consumer demand, which would somewhat offset the contractionary impact of deficit-cutting. Borrowers who have made payments for five years plus on high-yield mortgages are committed to keeping their homes and presumably have a reasonable level of income to stay current for so long (although any lending entails normal underwriting risks of death, job loss, and disability). But there is still a risk of bad incentives allowing the GSEs to serve yet again as stuffees. From the Wall Street Journal:
Under the proposal, Fannie and Freddie would be allowed to charge higher rates to borrowers in order to compensate for the risk of guaranteeing refinanced loans that are underwater and more likely to result in default. Some economists argue that those borrowers could be relatively good credit risks because they have been paying their mortgages through the financial crisis, and that Fannie and Freddie could turn a profit on such mortgages while helping the housing market.
But industry officials say such a program would work only if banks were given immunity from having to buy back any loans they refinance that subsequently default, and that such a shield would boost the risk for the taxpayer-backed companies.
Huh? Given that the FHFA has filed putback lawsuits against bank originators that would result in $200 billion or so of damages if the agency prevailed, why in God’s name would anyone give banks a liability waiver? Oh, it’s obvious why they want one, but given their past abuses, it’s reckless to give them carte blanche.
Another reason not to like the plan is that a win for borrowers is a loss for mortgage investors. Now one could take the point of view that these mortgages would have been refied in the normal course of events with interest rates being so low and the investors have perversely gotten lucky by virtue of the borrowers being so upside down that they can’t refinance. The reason I nevertheless have a wee bit of sympathy for the investors is that the Administration has treated them shabbily all along. Team Obama has chosen to coddle incompetent and miscreant mortgage servicers when it in fact had plenty of leverage to push them to make deep principal modifications, which would have been a win for both investors and borrowers. Instead, it implemented HAMP, and changed program design so many times that it was guaranteed to cause servicer problems, even before you get to their shameless gaming of the program. And in the mortgage settlement, the Administration upended the creditor hierarchy by allowing banks to only partially write off bank-owned second mortgages when modifying investor-owned first mortgages.
But this scheme is not a done deal; it requires Congressional approval. Expand the role of the GSEs is anathema to Republicans, so expect to see spirited opposition. The FHFA has indicated that in the abstract, it supports this sort of program, although the Mortgage Bankers’ Association is curiously cool:
Fannie and Freddie “have already proved that they really weren’t good at pricing higher-risk assets” during the housing bubble, said David Stevens, chief executive of the Mortgage Bankers Association. “What gives us the belief they can price it better today?” Allowing the firms to “reload up their balance sheets…will ultimately be a taxpayer expense,” he said.
The Journal also notes that the impact would be narrow:
Such a plan would likely reach no more than a few hundred thousand borrowers, or less than 5% of all outstanding mortgages. Some 24% of outstanding loans in privately issued mortgage bonds, representing around $226 billion in loans to about 900,000 borrowers, are current on their payments and underwater, according to estimates by analysts at Barclays Capital and J.P. Morgan Chase & Co.
The Administration is also looking at expanding HAMP by redefining the eligibility criterion that a borrower be at risk of “imminent default” to include deeply underwater mortgages. The American Securitization Forum has signaled its opposition to this idea.
The problem with all these schemes is that they are expanding subsidies to mortgage finance to achieve other ends, in the past, to prop up asset prices and serve as a stealth bailout to the banks and now, to support consumer spending. But extending the reach of cheap mortgage credit will make an exit from ZIRP even more difficult. That virtually guarantees the Fed will be too slow to raise interest rates if we are ever able to escape from the Japanification of the economy. While many investors are worried about inflation, new asset bubbles are the more likely outcome, particularly in structured credit. Despite the officialdom’s claims to the contrary, they aren’t even doing a good job of fighting the last war.