Administration Planning to Use Fannie and Freddie to Provide More Stealth Stimulus

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.

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  1. guest

    Tangentially topical from Taibbi

    Glenn Hubbard, Leading Academic and Mitt Romney Advisor, Took $1200 an Hour to Be Countrywide’s Expert Witness
    by Matt Taibbi, Rolling Stone

    Read more:

    Pamela Jones, writing on Groklaw, describes it: “I thought you’d enjoy another Quinn Emanuel lawyer interrogating an unwilling expert. These guys are good, I have to say, but an expert who wishes to sandbag, can be hard to crack. There are some language issues. And some incredible writing skills, as usual, with Taibbi. And it will put into perspective for you what lawyers go through trying to get straight answers from an high-paid expert at being an expert.” –

  2. Yonatan

    In a sudden outburst of honesty, the Fed announces from now on, the US dollar will be printed on toilet paper.

    1. Truman

      If you make a bad bet in Amerika you deserve to be bailed out. Check. I sure hope other countries are not watching this farce.

  3. ArkansasAngie

    Those who make bad decision face moral hazard.

    Those who do a good job get robbed of their money and given to those who have made bad decisions..

    There are consequences and if one of them is taking my money then … up yours. I work hard for my money. I spend long hours worrying with making good decisions.

    Just stop it already

    1. from Mexico

      The pious self-righteousness of comments like this becomes overwheming at times.

      There are any number of factors besides one’s own prudence and hard work which contribute to one’s economic success. Inheritance, dumb luck and good health all play important roles. Then there’s the manipulation by the rich and politically powerful to tilt the playing field in their direction.

      The world is not rational. It never has been and never will be. And yet there are people who persist in the deluded belief that the world is a rational place.

      1. wunsacon

        Seems a bit harsh.

        >> The world is not rational. It never has been and never will be. And yet there are people who persist in the deluded belief that the world is a rational place.

        Is there something wrong with complaining about the irrationality and wanting the world (or at least just human society) to be rational, fair, and compassionate?

        >> The pious self-righteousness of comments like this

        Yeah, well, that comment is true.

        The USG could implement a universal bailout, one that fights deflation without rewarding bad actors at the expense of good actors. It continually chooses not to.

        Don’t expect those who “live within our means” to be silent about it (even if our speech means nothing to you or government).

      2. wunsacon

        I completely agree with your second paragraph. But, it’s not necessarily at odds with ArkansasAngie’s comment.

      3. Lambert Strether

        I wouldn’t call it “pious,” since I don’t see any reference to The God(ess)(e)(s) Of Your Choice, If Any. I’d call it smug, and I get exactly the same from “creative class” supporters of ObamaCare. Not “good enough” to get into the ObamaCare lifeboat with a pre-existing condition?* Then you can jolly well wait ’til 2014 and be grateful for it.

        * * *

        All these comments really boil down to: “Your life means nothing to me; go die.”

        Most of the great religions teach against that, FWIW. I suppose I should write another “I fear for the Republic….” posts, but it gets tiresome after awhile.

        NOTE * I.e., already in the insurance system.

        1. from Mexico

          I don’t see morality as necessarily being a religious thing, as I prefer the morality of some of my atheist and agnostic friends and family members over the morality of some of my Christian friends and family members. I’m not sure from where morality derives, but I don’t think it’s religion.

          The Christian theologian Reinhold Niebuhr, nonetheless, speaks a great deal of morality, and especially the sort of morality expressed in ArkansasAngie’s comment. In Moral Man & Immoral Society he speaks of it more in secular terms and calls it “the middle-class ethic.” In The Irony of American History he speaks of it in purely theological terms and calls it “yankeeism.” Nowhere does he speak of it flatteringly.

          From a traiditonal Christian perspective, I suppose it would be called “Pelagianism,” the theological doctrine propounded by Pelagius, a British monk, and condemned as heresy by the Roman Catholic Church in a.d. 416. It denied original sin and affirmed the ability of humans to be righteous by the exercise of free will.

          The problem with this theology is that it goos over financial or other worldly success with a layer of moral superiority. Likewise, those who don’t achieve financial or worldly success are deemed to be morally inferior.

          Niebuhr explains that the original Puritan doctrine held that we are sinners who are given undeserved blessings by God. There is no rational justification for who God decides to bless and not to bless. We cannot understand him or why he does what he does. In this world bad things happen to good people, and good things happen to bad people.

          Puritanism, upon crossing the Atlantic Niebuhr says, quickly morphed into yankeeism. In yankeeism we are not blessed because God decided so, but because of something we did. Our blessings are thus not undeserved blessings from God, but something we earned. In other words, it is not due to God’s will that we are blessed, but due to our own will.

          I think it would be possible to stake out some sort of a middle gound between Puritanism and yankeeism. However, I have to tell you that I have a number of people in my family who take the yankeeism thing to an extreme, and I find it offensive and morally reprehensible. Essentially it provides the jusitification to morally condemn those who are poorer than themselves.

          1. from Mexico

            Yankeeism also allows people to mount their moral high horse for no other reason than because they are rich. You are rich, therefore you are morally superior.

    2. Paul Tioxon

      In the free market there are no bad decisions. Why would anyone intentionally ruin their own reputation, their credit score and face foreclosure by making a bad decision? The banking industry worked hard deregulating itself, just so everyone would be on a level playing field and self correct themselves automatically without judgemental neurotic worry warts like you, interfering with the perfect pricing mechanism of the market.

      If people should not have gotten a loan, the bank would not have lent to them. If people borrowed too much, the bank would have made the amount of the loan proportionate to the expertly arrived at home value by appraisers. Obviously, there is nothing the matter with any borrower who was approved for a loan, because it was not the decision of the borrower to approve themselves for the loan, but the infallible decision of the market, which has no reason to make bad loans. The only moral hazard here is your thinking!

    3. Sam

      Yes, it is really self-righteous of you to complain about being robbed. What is wrong with you? You’d better thank nice folks at government and ask for more.

      1. Lambert Strether

        You ought to get that knee seem to.

        It’s not government that’s the problem (modulo the anarchism permathread, and I don’t read your comment that way).

        It’s the people who own the government and are robbing us all blind.

      1. wunsacon

        Hi Lambert, are you being serious here? Printing new (credit or money) increases the amount in circulation and depreciates the purchasing power of my savings and my yearly salary. The inflation tax is a tax.

        1. Lambert Strether

          Of course, we don’t really print money; money’s digital, kept on spreadsheets.

          * * *

          If the government’s net contribution of money to the economy increases, that only causes inflation when the economy is at or near capacity. We’re nowhere near that point.

          1. wunsacon

            Hi Lambert,

            Sorry in advance for the rant but…

            I would’ve liked to buy my first house if prices fell another 20%. Instead, they’ve bounced 30%. (I don’t care what Case-Shiller says. I’ve been following comparable houses in a few markets. The best deals are at least 30% higher than the best deals I was finding a few years ago.) The Fed’s resuscitation of lending (to barely or non-qualified borrowers rubbing two nickels together) kept me out of the market. Now, I can’t afford anything I’d actually like to live in without playing Russian roulette with my savings and financial future. Prices are too high again.

            So, what’s not “at capacity”? Why has gasoline doubled in price? Why is my rent rising 5%? Why can’t I afford a house? Why are stocks overpriced and why do bonds and savings accounts pay nothing to me for the “wisdom” of me actually trying to live within my means in order to save up for larger purchases?

            What does your model say about the fact my money goes about 50-80% as far today as it did 4 years ago? I say I’ve been taxed via inflation. The USG/Fed/Fannie/Fraudie have taxed my savings heavily.

            If, by chance, you weren’t hoping to make any big purchases (e.g., a house), perhaps you don’t think of the impact this has had on savers like me. (And who does inflation hit more if not “savers” — people who tried during the boom times to live within their means?)

  4. Esohbe

    If they refi people who have been in their homes for five years or more and nothing is done with the principal no problem is solved. A typical home is occupied for eight years – then people either move up or down or relocate. When this event occurs they will still be underwater. Will they default on the mortgage? Probably. This program and the rent program kick any housing solution into the future and provide a little political cover, nothing else.

    1. Yves Smith Post author

      I didn’t go into that part of the argument, but yes, the view by Merkeley et al is that an interest rate reduction is economically equivalent to a not all that deep principal mod.

      And the WSJ story makes it clear this isn’t about helping these homeowners with their homes so much as giving them some more spending money, an estimated $2600 a year, to be precise.

  5. Crazy Horse

    Delusional in Arkansas,

    Let me supply names for your comments:

    #1 Face moral hazard for bad decisions?—Jamie Dimon, Jon Corzine, Tim Geither, Bill Clinton, George Bush, Barack Obama,and a cast of thousands? In your dreams.

    #2 Robbed? Every person in the US who has money in a pension fund strip mined by banksters, visits a doctor or hospital, buys monopoly medicines, or pays taxes to support the imperial army cloaked as “defense.”

    #3 –up yours? Glad to see that the spirit of revolution is alive in your state. So when are you going to mobilize instead of “spending long hours worrying”?

  6. LillithMc

    In Sacramento where mortgage crime was rampant we have a report of a homeowner who walked away from his home down about 70% in value, waited the required 2-3 years and now has qualified for an FHA loan. FHA has been a respectable loan system that didn’t work in Sacramento when Wall Street captured the market because Congress would not raise the FHA loan amount above the rapidly rising prices. With a rash of mass purchases by hedge funds, one person who survived the crash now owning a home again instead of renting from the absentee landlords is a tiny bright spot. Before the crash home-ownership was above 50%. Now 2/3rd of the county is in blight heading for slums owned by absentee investors. It would take many FHA loans to offset the massive money pumped in from Blackstone.

    1. Chris

      I wish we’d just get this mess over with already.

      The banks don’t want to come clean on anything because the extent of the problems will scare the $hit out of investors and the market will freeze up again. And that’s true even if you ignore commercial property loans which are also in terrible shape. But we’ve decided more efficient foreclosures would be horrible for home owners so there’s no quick way to fix the problem. And given the way rent is sky rocketing and people’s credit ratings can be used against them I agree.

      So why not just do something bold to break this up and prevent future bubbles for the next bit?

      Say, give everyone that sells a house this year the ability to deduct 100% of the difference between their sell price and their mortgage value from their taxes, in a dollar for dollar refundable credit. If youre not underwater on your mortgage, you keep the funds from the tax return. if youre renting, or not selling, then we just give people a decent chunk of money, say 10k$ and call it even. its not targeted or efficient, but you break up the problem and provide some stimulus too.

      And we could allow people to take an advance on the funds to pay the bank the remaining funds owed. And then we could get rid of the mortgage interest deduction and replace it with something that’s means tested and applies to primary residences only (even if they’re rented). Then you can wind down the GSEs and let the market get back to working.

      These might be horrible, crappy, ideas. But I don’t think more tinkering at the margins or playing games with the banks is going to do anything positive.

  7. Cynthia

    The winners will be the banks, of course. The legislation is designed ostensibly to help underwater homeowners get some relief on their overburdened finances.

    What it really does is modify the loan in order to lock the person in the mortgage so the banks suffer far fewer losses.

  8. Javagold

    so people refi, they will be still underwater…..what happens when they want/need/have to move…..They are going to Bring a check to the closing ????…..

  9. steelhead23

    There are times when the right thing to do seems outwardly crazy. This may be one of those times. Firstly, this program would spend money into the economy – staving off recession. Secondly, it keeps folks in their homes and their homes off the market – reducing the tendency for housing depreciation. Thirdly, it is aimed precisely at middle America – workers – with depreciating wealth. Of course, it also clobbers MBS bondholders, including individuals and pension plans. And it increases that bugaboo of the fiscal “adults in the room” – deficit spending. My view on this plan is simple – the GSE should not reduce any of its risk analysis except loan to value and millionaires need not apply (a means test). Otherwise, as a homeOWNER and taxpayer, I abhor this plan – except for the fact that it is the right thing to do.

    1. NotTimothyGeithner

      Its the lazy thing to do wrapped in good intentions (this pretty much sums up the Obama Administration). The right thing to do is to fire that piece of shit Eric Holder and announce a program of prosecution against the banks. My guess is they will be willing to avoid criminal time in exchange for reforms, and hey if they aren’t, they won’t be able to lobby if they are in prison.

      Looking for some technocratic bullshit to explain away refusing to deal with the system is a lazy and selfish thing to do.

      1. steelhead23

        Methinks you are a tad too harsh. I absolutely agree with your suggestion to prosecute the banksters, but that doesn’t really solve the underwater homeowner dilemma. Here is a question Merkley et al. have likely considered – “What fraction of currently underwater homeowners would have to play jingle mail, or face foreclosure before the costs to GSEs became unmanageable?” Further, Geithner has stated (a few Christmases ago) that the U.S. Treasury stands behind all those GSE bonds – bonds that would be at serious risk if a large fraction of currently underwater homeowners went bust. Short of a coup, Merkley is powerless to change that. The banksters have been let off the hook and have been bailed out. What are those hapless underwater homeowners – chopped liver? If this administration were not in bed with the banksters, I would agree with you – let the foreclosures, bond failures, and bank failures proceed and we’ll pick up the pieces. Merkley may be working with Treasury on this, but his position on prosecuting banksters certainly is not in line with the administration.

  10. Tony

    Yves, I have a hard time squaring the views you express in this post — views with which I agree — with the fact that you also advocate Ed DeMarco’s removal from office. (DeMarco would also probably agree with your post.)

    Please tell us again why you think Ed DeMarco should be fired.

  11. heresy101

    Can anyone provide a link, or point to sources, for the value of residential mortgages that are a) held outright and b) guaranteed by 1) Fannie, 2) Freddie, and 3) the FHA?


  12. tiebie66

    I do not understand the modification as stimulus – would the higher fee not counter the stimulus? Is it not shunting money from A to B with no/little net stimulus effect? Are the targeted homeowners more likely to be irresponsible and spend while those that contribute are more likely to be the opposite? Or is it a backdoor way to provide more liability immunity with the banks being careful not to be unseemly enthusiastic about it?

    Regarding some of the comments, it strikes me that “ArkansasAngie” and “from Mexico” are both right, no?

    To harvest, one needs to plow and sow. This is the moral hazard part. No effort, no harvest. However, plowing and sowing, by themselves, do not guarantee a harvest. Weather, pestilence, banditry, to name a few, may intervene. This is the luck, unplannable-for, part. It is a two-dimensional problem for which any one-dimensional interpretation is likely to be inadequate.

    Unfortunately, we can deceive by claiming “good planning” when it was luck; by claiming “bad luck” when it was poor planning…

    The problem is finding good short, medium, and long term solutions and the spine to implement them. (Now, having stated the obvious, I’ll have to duck…)

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