The administration's housing plan seems well thought out. All three parts address clear weaknesses in the present arrangements.
The refinancing element, aimed at borrowers in good standing, allows Fannie and Freddie to refinance loans where the value of the mortgage is between 80% and 105% of the value of the property. Up to now they have not been allowed to do this (unless the mortgage is insured). Many borrowers in good standing have seen their loan-to-value ratios climb into this range because of falling house prices. The rule preventing refinancing at current lower rates is self-defeating from the agencies' own point of view, since it increases the chances of default. The plan puts this right--helping both the GSEs and their borrowers. (Some complain that the change only helps borrowers with loans owned or guaranteed by the GSEs. Well, yes, those were the loans affected by the restriction in the first place.)
The loan modification part is aimed at borrowers who are at imminent risk of default, and is modeled on the scheme that the FDIC has been testing and advocating for some months. An explicit public subsidy is involved--to the tune of $75 billion--which in effect will be split between lenders/servicers and qualifying distressed borrowers. Lenders and servicers get cleverly structured incentives to reduce monthly repayments to 31 percent of gross income. (Note that modifications up to now have been few and far between, and have often left repayments unchanged or higher than before, once penalties and arrears have been added back.) Lower repayments obviously lessen the risk of default.
The administration says that its scheme does not reward people who recklessly borrowed too much. This is untrue: the plan will certainly help some people who borrowed more than they should have. No doubt, it would be fairer to help only borrowers whose standard repayments (after teaser rates expired) were no more than say 30 percent of gross income to begin with, and/or who borrowed less than 80% of their property's initial value--in other words, to help only borrowers who behaved prudently, and who are now in trouble because their income has fallen. But of course this would have meant many more defaults. Because foreclosures also hurt innocent bystanders, there is a public interest in limiting them. The second part of the plan, I think, is indeed unfair and does raise moral hazard concerns--but I'd say that is a price worth paying if it stems the tide of foreclosures.
Will it succeed in doing that? It certainly gives loan modification a much firmer push than seen up to now. Lenders will not be forced to modify, but TARP beneficiaries will have to apply the guidelines, and show that they are making an effort. The new prospect of bankruptcy-court cramdowns (this requires legislation) should also help to focus minds. A standard Treasury-endorsed modification template ought to ease some of the worries servicers have about being sued by investors over unauthorized modifications of securitized mortgages. An important question is how far cuts in repayments will be achieved by interest-rate reductions as opposed to cuts in principal. Many observers reckon that principal reductions would curb foreclosures more effectively. The plan sees principal reductions as a possibility, but the incentives appear to grant that method of reducing repayments no special favors. Maybe this will have changed by the time we get full details of the plan next month.
The third part--$200 billion of new capital for the GSEs--improves Fannie's and Freddie's ability to buy mortgage-backed securities, supports the market value of those securities, and keeps downward pressure on the interest rates lenders charge mortgage borrowers. This too makes sense.
I'm sure the plan will reduce the rate of foreclosures--as compared with a no-plan baseline. How much it will reduce them, and whether that will be enough to stabilize the housing market, is impossible to say just yet. But after many months of almost total neglect, this is a big step forward.
"Because foreclosures also hurt innocent bystanders, there is a public interest in limiting them."
I really wish someone could explain that Megan and the commenters on her blog. Maybe using sufficiently small words?
I disagree, the new plan mucks up the marketplace and crowds out buyers who would buy from soon-to-be foreclosed on property. First, because lenders need to digest the new rules, price in the bankruptcy provisions and consider their policy in this new interventionist environment. Second, buyers are waiting for a bottom, and this policy fights that off and props up the seller side.
In L.A. we've already fallen to normal income-cost ratios and entering the overshoot. This plan stalls the process.
It's time to examine a little more closely the notion that "foreclosures also hurt innocent bystanders" since that is the lynchpin of the entire plan. Without that premise, there would be no reason of any kind to bail out underwater mortgagors.
I can only think of two possible meanings to this claim. One is that foreclosures can hurt innocent neighbors because they result in empty houses sitting around, and those houses end up being vandalized or otherwise not maintained, and that hurts values in the neighborhood beyond the normal play of supply and demand. There is a solution to this problem that does not entail taxing the ants to support the grasshoppers. That would be to streamline the foreclosure process (right now, many state laws permit borrowers to drag things out for months), allowing lenders to foreclose quickly, and require that the lenders either sell the property or rent it out within a short period of time, say 60 days. Rresult: new owners move in (former renters taking advantage of fire sale prices), take care of the property, and the neibghborhood moves on.
The other possible meaning is that foreclosures are bad because forced sales of these houses depress prices. So, the thinking goes, the Government must spend hundreds of billions of dollars to prop up real estate prices. This strikes me as madness. What we should want is for real estate markets to fall the point that they start clearing. Those markets cannot possibly even start to rebound until that happens.
very refreshing article , some angry people have forgotten that people with foreclosure and debt issue also pay taxes . they also forget that their neighbors may also owe an additional 30% more for the same or similar home just purchased a few laters than of the time of their home.
its said , but homes are not suppose to be bad investments. I for one want to keep my home at all costs , but when you add a depleted 401k retiremnets funds and college funds near at completed its not hard to find other priorties
I for one would benefit from a cram down , but i would prefer a 1 or 2% interest rate on the crammed down lost equity , enabling our home to re-coop faaster . we dont want hand outs but when the incentive is to walk away from the home . who loses more the neighbor with a floreclosed home next door driving down costs or the economy allowing one more homewoner to be a burdon on this economy..
very well written article , thanks for letting me vent
The problem comes when you put yourself in your bankers shoes and ask "What am I going to do tomorrow?" Suppose you want to give a moderately risky home buyer a loan, you will ask for a small additional cost to offset the risk (actually, given the number of loans in the country, the actuarial reality) that some number of these loans will fail.
But now the government can come in and force you to price the loan below your expected cost for servicing it. The answer is of course that unless the borrower has exceptional credit, you do not loan them any money.
The position on the secondary mortgage market is far worse. Banks currently buy and sell mortgages to convert future earnings into present capital, or vice versa. No one cares what the 'original' amount of the loan was. A secondary loan only cares about the risk of default and the amount of the payment. So if a lender is recieving $1000/mo in interest and decides that a 5% return is acceptable it will offer $20,000 + principal remaining (since loan payments are fixed the math is actually a little more complex, but the basics remain the same). Now if that loan is an "8% loan" the value of the mortgage can be reset, and if you bid money for it, you have an additional risk that you will not see the return covered by the contract.
The net result will be once again to dry up the secondary market and prevent re-sale of assets at what should be market prices. No one wants to make loans they can't re-sell, because it ties up the bank assets forever. So instead, they will look for 'good' risks.
This bill will drop millions of people from the rolls of people who can be given a mortgage, not because they can't pay for it, but because the bank has no way to calculate a fair price for it.
Drying up demaind for housing just drops housing prices further, and will not help but hinder recovery. Instead of looking at what the 'bill' does, look at what rational actors will do if the bill was the law of the land.
This is good for people who rent property, as demand will increase and they will be able to charge more rent to renters without fear that they will buy themselves a house. But it surely wouldn't be good news for anyone else.
Perhaps we need to think things through for more than a few hours before they are well thought out.
Doug
Yes, this ~$1000-per-American plan will reduce foreclosures some. Most of that reduction will probably come from part #2 (loan modification), which directly targets insolvent homeowners. Whether their rescue is deserved, or stimulative, or a good precedent are questions for another time. But part #1 (refinancing) and part #3 (GSE expansion) are just plain bad ideas, even if you believe that saving insolvent homeowners from foreclosure is a good idea.
Part #1 (refinancing) may help save a handfull borrowers who are solvent now but whoose finances will deteriorate in the future. But because it is targeted at currently solvent homeowners, it is mostly a giveaway: it ensures that solvent, upper-middle-class homeowners who purchased an an inoppertune time in the cycle can refinance at the same juicy low rate as their solvent, upper-middle-class neighbors who purchansed at a more propitious point in the cycle.
Part #3 (GSE expansion) is a counterproductive expansion of the system that got us into this housing crisis. Every other Anlgo-Saxon country manages to achieve a similiar homeownership rate without massive subsidization of the housing sector. We should be shriking the GSEs, relying more on private-sector financing that will make homebuyers pay rates that reflect default risk. (We should be eliminating the mortgage interest deduction, too, but that's a hopeless battle for another day.)
You mention:
"Lenders and servicers get cleverly structured incentives to reduce monthly repayments to 31 percent of gross income."
It is unclear to me how the current incentives work when the mortgages are held by third parties in mortgage backed securities? Are foreclosures profitable for banks and servicers when a third party is holding the loan?
The Tarp modifications outlined appear reasonable for banks that have mortgages on their books. But in the case of the mortaged-backed securites it appears murky, do GSE purchases of the mortgage backed securities enable them to rip up the legal documents outlining how defaults and foreclosures are to be dealt with?
Left unsaid is why we need to stabilize home prices or prevent foreclosures in the first place. Prices need to fall back to the market clearing price - the long term trend line. Many months of almost total neglect was much better. This travesty gives the irresponsible a free lunch, while people who own their homes outright and renters get screwed. Sounds like a great plan.
The Washington Post reports today that the Obama Administration has all the details worked out … except for who gets the money.
Obama went to Arizona to announce the plan because of the giant number of foreclosures there, but the worst case scenario in his plan is a family that bought in 2006 and is $25k underwater and paying 42% of their income on their mortgage. In reality, most people in trouble in Arizona are over $100k underwater and looking at 50% of their income going to the mortgage. And let’s not even talk about California.
Geithner and Summers probably understand that there’s not enough money in the world to bail out the Bubble in the four Sand States — Arizona, Nevada, Florida, and California. But, by choosing Arizona for his big announcement, Obama signals that he doesn’t likely understand that a plan limited to people 25k underwater will mostly help people in Red States in the middle of the country. Obama seems to think his plan will convert heavily Hispanic Purple States like Arizona, Nevada, and Florida to Blue forever.
The president is making a tragic mistake forcing hard working people to pay for the mistakes of others. I can't think of a more effective way to creat deep anger among the hard working people.
Rewarding bad behavior, poor decisions and stupidity, that is the B.O. plan. And like president B.O. it stinks.
This plan is a disaster. The "Cram down" Bankruptcy provision will make lenders very wary to make new loans and when they do, they will HAVE TO charge higher rates, further depressing the market. California has been one of the hardest hit states. ur market WAS self correcting, prices have fallen to the point where homes are affordable again...now this. Govt. intervention is not the answer, leave free markets alone.
So what happens if in 5 years the economy has recovered and home values return to near their former values?
The guy whose house is worth $100k less today, after this new financing scheme, may find himself with a $50k profit 5 years from now when things come back. Meanwhile the other 90% of us who did not buy more than we could handle will be back to break even.
Clive, you completely miss the obvious.
You acknowledge that It is patently unfair to most Americans, but you don't see that, "that trumps all other concerns".
Back to political kindergarten for you.
The plan will more likely buy time for people who really should not have the houses. Even in good economic times, there is a baseline foreclosure rate. The assumption that keeping people from being foreclosed upon is specious. Many of them would do better to lose their home and go back to renter status.
Sort of like GM and Chrysler. They should go bankrupt and reorganize. Loans stave off the inevitable.
Finally, any way you cut it, people who behaved responsibly are being punished by subsidizing those who by and large do not.
Sorry, does not compute. Besides, guarantee that they will be back for more, and more, and more....
What we are seeing is the explosion of an asset bubble that was driven by easy money from the fed and easy loans backed by Fannie and Freddie. How exactly is reinflating the bubble going to help? You say it will help people, but it's just a short term feel good measure that only exacerbates the underlying problem that got us here in the first place.
Your assessment ignores a basic fact. The delay to renegotiate mortgage loans has been the direct consequence of the expectation that sooner or later the government was going to intervene (anyone familiar with financial crises knows that this is the case). When the government finally intervenes the relevant question is if borrowers and lenders believe that there will be a second intervention--and indeed there may be many reasons to expect another one. In this particular case, given the uncertainty about the future of private banks and the certainty about the future of GSEs, there will be new interventions. If you want to address seriously a financial crisis you announce the full package together and explain in detail so most people understand why they should not expect new interventions.
This problem started because house prices were too high. There were fewer houses each year that were 30 percent of a working persons gross income. Now that housing prices are falling the government wants to stabilize house prices.
Foreclosures were bringing prices down to levels that responsible working families could afford. It doesn't matter how much the value of surrounding properties are worth. If someone bought a house to live in instead of an investment then it doesn't matter if the "value" of the house drops 50 percent because of too many foreclosures in the neighborhood.
They are not worried about working families, they are worried about their rich investor friends and the falling property taxes on cheaper houses.
The key is the market has already devalued these properties. So this plan isn't really helping out the "losers." but actually addressing the short term failure of the market to adjust and a convoluted mortgage system that has been used as an investment vehicle for people, who have no stake, in the local communities. It's a step in the right direction but it will not address the majority of owners who will still not qualify due to credit card debt and low wage jobs.
Ok, so if the guy has not paid his payments, he all of a sudden.. starts
Because of some guidelines??????
get real
and the best part
the 92% of us who do pay, get to pay his as well????
the old show barney miller had a great piece in financial investments. the detective who wrote blood on the badge was buying gold and saying what a great investment gold was because it was then about $750. jack soo turned to him and said that gold was worth only what the next person would pay for it. the foreclosure market will reset values for houses in florida, michigan, nevada, california, ... the government can't tell people what price to pay for their house and just like in 1987-1992 or so - housing prices will reset lower. we have been here before. people who pay their rent and people who pay or have payed off their mortgages should not pay other peoples mortgages.
Megan wrote:
"The administration says that its scheme does not reward people who recklessly borrowed too much. This is untrue: the plan will certainly help some people who borrowed more than they should have."
I am literally dumbfounded by the fact that your post makes no mention of loan officers who are employed by banks to manage loan portfolios. We can certainly agree that millions of borrowers were blatantly stupid, but what shall we say of the loan officers who approved their loans??
Is it not the job of a loan officer to mitigate risk? Are banks nothing more than the willing and complicit dupes of greedy borrowers whom they cannot possibly resist? You seem to assume that they ARE!!!
If it's all the fault of the borrowers then why on earth should banks employ people to evaluate the worthiness of a loan request?
Your proposition is preposterous on its face. Some person within a bank must be empowered to DENY a loan request, regardless of any hopeful borrower's greed or recklessness. Your argument oddly takes no account of the fact the such a loan manager could possibly exist.
You seem to be telling us that bankers cannot be expected to manage their own banks. Bad loans are somehow ALL the fault of borrowers. If this is really the case and I want to start a new bank then why on earth should I bother to hire someone to manage my bank's loans?
A person who reads your post can only conclude that a bank exists to do no more than surrender to the request of any potential borrower. Do tell us more.
And now, you're saying, another 275 Billion is needed to help with the housing problems? How much further will this go on? And George Bush was the one who spent too much money???
Clive, help me understand you here:
(1) Your first point, nominally about refinancing, seems really to be about PMI. I've always had to have PMI; I understand it, it seems to make sense to me. Yet you seem to be saying that while the GSEs required PMI for equity less than 20%, that was somehow uniquely hampering one segment of the market, and it is a good thing, with no downside, that we get rid of PMI? I can see someone trying to make the case, but you seem to take it for granted, as obviously true and not in need of supporting argument.
(2) Subsidizing people at risk of default, to prevent default, seems wrongheaded on many levels. First, of course, it may only cost money without really addressing the problem. Solutions like this fail to acknowledge that default on mortgages is a logical response to incentives. The appeal of default to borrowers is only slightly reduced by reducing their payments; it is substantially reduced only by increasing their equity. Default on a mortgage does not require bankruptcy, and all of the borrower's assets other than the home are protected. The only substantial disincentive is having to walk away from equity. Absent equity, then even with reasonable payments the borrower may have good reasons to default, e.g. a desire to move to another location, or the 8-12 months of rent-free living he gets if he manages his default carefully to avoid early eviction.
(3) But the other problem with subsidizing those in their homes with no equity is that there may well be other emerging first-time homeowners out there in better shape to take on stewardship/ responsibility for the house. Given that such people undoubtedly exist, isn't it only justice (as well as in the public interest) to focus instead on expediting and streamlining the process of default, foreclosure, eviction, and rehabitation? Foreclosure as we do it today is a costly process, but only because we put so many legal/ procedural barriers in the way; we treat foreclosure as an unmitigated negative to be blocked at every turn, thereby creating the very costs that we claim justify minimizing foreclosures. Treating foreclosure as a simple business transaction, with removal of the obstacles, eliminates much of the cost, and facilitates occupancy by new owners.
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No, this logic is flawed on two major points.
1. The GSE has been giving loans it shouldn't. This was a substantial cause of our current dilema. Allowing further refinancing at fake rates is an imprudent attempt and keeping air in a balloon with many holes. Defaults should be allowed to happen where they happen. The housing prices will eventually stablize as those responsible buyers rise to the top.
2. The bailout (or worse, the cramdown of a Judge re-writing a mortgage or principle!) will destroy the source of fresh mortgage money for years to come. Who in there right mind will provide funds for mortgages at any reasonable rate, when the government backs and promotes default by the home buyer? Even if you somehow succeed by taxes the dickens out of the responsible home owners, this will delay the inevitable but even worse crash that will follow.
Alright...you like the plan. Why shouldn't I stop paying my current mortgage (less than 80% of house price/30yr fixed @5%) in order to join the party and get my neighbors to pay for my mortgage?
I mean if the govt. is going to give away money...why shouldn't I benefit? I pay my taxes, obey the law, vote. Why should I have to keep paying on my house at the current rate?
Why don't I DESERVE a break too?
Not discussed but needed in the plan is system to claw back the modifications (and perhaps a premium as well) when home prices rise. Many people expect the 'stimulus' as well as the other massive government spending programs will inevitably lead to big round of inflation that will in turn push home prices way up.
If over 90% of people are current on their mortgages just how big of a rising tide are we talking about? If you further look at the data there are huge concentrations of where morgages are in default that correspond to the worst overbuilding and bubble prices.
It would take weeks to distinguish the responsible from the irresponsible borrowers and I have a very, very strong suspicion that the overwhelming majority of people in danger of foreclosure bought houses they couldn't afford at inflated prices that couldn't be sustained with no money down adjustable rate morgages. And there is no rationale reason why any of these people should be helped. Let them rent.
This plan is pure folly. The housing market will eventually stabilize at a lower rate if we simply leave it alone and take our medicine instead of propping up and rewarding bad behavior.
I fail to understand why something that is so basic is being ignored by so many.
The possibility of mortgage cramdowns, and any possible Treasury template as a defence against shareholder rights, ensure the continuation of the capital strike against the financials in particular and equities in general.
New capital for the GSEs = an attempt to borrow them into solvency. Just means the thud will be louder.
Policymakers are still playing King Canute with mortgages-for-the-improvident. ("We command the bill not to come due!") And then, throw in the 2000-points-off-the-Dow potential of regulation of CO2 as a pollutant. Suddenly the fearful ex-investors sitting on their depleted cash don't look quite so timid after all.
The market has spoken, and it's relentlessly short on these policies. With no transparency in the financials, and contracts subject to arbitrary revision, the confidence the market stands upon has been undermined, and each new spastic panic attack from the White House, Treasury or the demagogues in Congress undermines it further.
The most consistent criticisms of the housing plan (McArdle's blog,) concern helping deadbeats who bit off more then they can chew, and include frequent suggestions that it would be better for banks to continue foreclosures and rent properties until the market recovers.
I've been watching the housing market in Portland, ME for four years now; and a foreclosed property put up for sale typically comes "as is," and frequently includes warnings about frozen pipes and water damage.
Which leads me to think that banks don't make good landlords, they don't have much interest in properly maintaining a property to hold its value. Property management, it seems, is a distraction from the business of banking.
I have been in this business a long time and I totally disagree with you for the following reasons.
Refinancing Part. The majority of the homes in trouble were purchased from 2004 forward. Home values have dropped overall around 40% from that time and most of the homeowners in trouble only put between 0% and 10$ down making the majority of homes in trouble not able to qualify. While it may help a small number of homeowners that probably didn't need it to start with there will still be homes going to forclosure in your neighborhood and your property values will still suffer because of that.
Loan Modification Part. To start with if Cramdowns are put in place it will kill the housing marker. Lenders will be forced to raise rates out of reach of most people to cover that risk. When government starts saying to business that your contracts aren't worth the paper they are written on you will see a total collapse of commerce.
The other part you forgot to mention under this scenerio is that the government is only offering these modification up to $5,000 or $6,000 net dollars and expecting lenders to come up with the rest. To reach 31% of there income most of these homeowners would need a modification that would cost in excess of $20,000. I don't see it happening. Again while a small minority may end up being helped there will still be forclosures.
Bottom line is that these government programs are in no way broad or large enough to put any type of false or real bottom in the market and so far 45% of people that have recieved modifications have gone back into forclosure within 6 months.
An underlying assumption in your analysis is that foreclosures are bad. Not so.
Foreclosures do not equate to homelessness: rather, "owners" can become renters. And my neighbor's house being foreclosed on does not affect my home's ability to provide shelter. The primary "negative" societal effect of foreclosures is lower valuations that may limit the value of nearby housing to serve as collateral for more borrowed money. Given that our fundamental problem is too much leverage, that's a good thing for the economy at large.
Foreclosures help a market finish the bottoming process quickly - rather than the zombie effect that results from propping up prices - so orderly and rational valuation can follow. Importantly, foreclosures creat many new opportunities for investors and for new homebuyers, especially those who have been more prudent and reasonable. Thus, foreclosures reward the behavior that we need.
For proof of these processes, check out what happened to Houston (where I live) in the 1980s.
While I agree that provision #1 makes sense; provision #2 is just plain bad. Why should people who made a bad decision get to benefit by getting a bargain price and/or payment on house. In 5 to 10 years when the market recovers and they make money when selling their house -- do they get to pay back what they make on their house? How about people who are only in this situation because they chose not to re-invest equity from a previous house or from refinancing? Why should they be helped? I'd be ok with a plan that offered temporary help to people whose income had fallen dramatically due to job loss. Or a plan that offered things like insurance for 40 year mortgages (perhaps the rates on these could reset periodically but over a long enough time period that folks could adjust). But this plan just rewards bad behavior. It makes me deeply angry.
Why not have the government reduce the principal outstanding on all mortgages by a fixed amount, say $20,000. This avoids the moral hazard problems, which are extreme. It will not prevent as many foreclosures as the more targeted plan but it provides all the neighbors with some price protection.
With a ceiling set to not deal with mortgages over a few hundred thousand dollars, for which $20,000 would not be meaningful relief anyway, this is affordable. For the $800 billion spent on TARP we could pay down $20,000 on 40 million mortgages.
Dear Mr. Crook:
This is insane. This problem is mostly the result of stupid behavior by greedy people, mostly in five states (CA, FL, AZ, NV and MI). I pay my mortgage every month, on time, just like millions of other Americans and you are now trying to tell me it's my duty to bail these clowns out. These people VOLUNTARILY signed CONTRACTS. Nobody put a gun to their head. Many lied about their income, most totally ignored the consequences of an interest rate reset and I'll bet you sure as all get out that damn few (if any) put 20% down like I just did last year. So now what? Blow up contract law? If you guys want to wreck this economy completely go ahead and keep doing stupid crap like this. The ridiculously high real estate prices that still exist in CA need to come back to normal (they're still 50% higher than 5 years ago) and if it requires foreclosure then so be it. I am NOT interested in paying my money to support high real estate prices in CA or FL.
Nice analysis. It is unsettling to hear those in the know express so much uncertainty, but such is life.
I would feel a lot better about it if it required that the original loan application be reviewed for truthfulness as regards income, assets and other debt. I am willing to swallow hard and let some people who don't really deserve it get some benefit if it avoids a worse problem, but I draw the line at rewarding fraud.
As moral hazards go, that's too much for me to swallow.
As I understand it, this program has no such protection.
Wouldn't $15,000 tax credit for any home buyers a more straightforward, effective, less expensive solution then the current Obama housing plan?