The next stage in the Obama administration's Home Affordable Modification Plan (HAMP) kicks in today, with a new wave of "short refinancing" incentives. The new plan will allow banks to refinance borrowers into Federal Housing Administration-backed loans while writing down the mortgages to less than the value of the property. Ideally, this should eliminate the negative equity of the borrower while providing the bank with a more reliable, though less profitable, mortgage.
Of course if there are any losses on the loan, the FHA (a.k.a. Joe Shmoe taxpayer) picks up the insurance tab at little to no cost for the bank. In order to pay for these expected losses—according to The Wall Street Journal officials are preparing for a 20 percent default rate—the White House has set aside $14 billion from the TARP fund that was already earmarked for housing recovery.
Yes, the program that was passed by a terrified Congress to let Henry Paulson buy up toxic mortgage backed securities but was then used inject cash into the savings accounts of banks will be covering mortgage delinquencies through the FHA.
Nick Timiraos of the Journal writes:
One of the biggest dangers facing the housing market is the glut of underwater homeowners who could default if their personal finances or home prices worsen. About 11 million borrowers, or 23% households with a mortgage, were underwater as of June 30, according to CoreLogic Inc.
The White House hopes to reach borrowers like Irene Gerloff, 62 years old, who was turned down for a loan modification because she can afford her payments. While she owes $292,000 on her two-bedroom condominium in La Habra, Calif., the property is probably worth less than $200,000.
She is worried about what happens in five years, when her "interest-only" loan begins requiring much larger payments. "If things don't improve between now and 2015, I'm going to have to let this house go," said Ms. Gerloff, a secretary.
But not every homeowner who is underwater can participate. The bank or investors that own the loan must be willing to write down its value.
The problem here is not that banks are writing down mortgages. The problem is that the FHA is offering an insurance program putting taxpayers at risk through a spending program that was never designed for this.
Of course, the issue of refinancing and modifying mortgages is quite complex. Timiraos continues:
officials hope to reach more loans that were bundled by Wall Street firms and sold to investors as mortgage-backed securities. For more than a year, many of those investors, which include hedge funds and pension funds, have been clamoring for such a program because they have already had to mark down the value of their holdings.
"It'll take some really crappy loans out of the marketplace…and replace them with much higher-quality" mortgages, said Scott Simon, a managing director at Pacific Management Investment Co.
But that could be hard to do because mortgage servicers, which handle loan payments and decide which loans should be modified, are overwhelmed. And some borrowers might be discouraged from taking part because receiving a principal reduction will show up on their credit score.
Moreover, investors may not be able to participate as hoped because certain contracts that govern mortgage securitizations say modifications can only proceed if there is an "imminent" risk that the borrower would default.
Reducing balances for borrowers who are current could open mortgage servicers to lawsuits from investors that hold the riskiest slices of bonds. Those investors would be wiped out if balances are greatly reduced. For that reason, "lenders are going to be especially reluctant to do short refinances on folks who are current," says Alan White, an assistant professor at Valparaiso University in Indiana.
Read the rest of the Journal article here.