President Obama was right when, after outlining the revised framework for the Home Affordable Refinance Program (HARP), he claimed the changes “will not solve all the problems in the housing market.” The question is, though, what problems will HARP II solve?
A general overview of HARP II was announced on Monday with operational details to be released November 15. Analysts at British bank RBS estimated that just 17 percent of the 30-year loans owned or guaranteed by the GSEs will qualify to be refinanced under the new FHFA terms for HARP. While this estimate works out to about 1.9 million mortgages, other estimates go as far as claiming 4 million underwater mortgages will qualify for HARP II.
From a purely free market perspective, this program could be worse.
- The best thing is that participation in the program on the part of lenders is optional. Either the current bank owning the mortgage could refinance or another bank could offer to refinance a mortgage away from the owning bank (both standard practices), but no bank will be forced to refinance.
- There is also no direct outlay from Treasury in this plan. Whereas HAMP was shelling checks for modifications at $1,000 a pop, the HARP program does not require that kind of spending. However, there could be a cost to taxpayers. Part of the plan is to remove certain fees that Fannie and Freddie charge when a mortgage they own or guarantee is refinanced—this is viewed by FHFA as good business practice and it has saved taxpayers money because the fees generate revenue to offset some of the taxpayer bailout of the GSEs. Since pretty much every quarter the GSEs are asking for a few billion from Treasury, every lost dollar at the GSEs towards their bottom line is a dollar taxpayers will have to fill to keep the GSEs solvent. So removing the fees does lower the revenue stream and could lead to higher taxpayer costs. However, if the refi allows a struggling homeowner to stay in their home and not default, the cost of less fees might be lower than the losses associated with a foreclosure. It is difficult to know whether the refi is needed for that, and it is fair to argue that the government doesn't always have the best people trying to make those business decisions. But it is not a guaranteed loser for the taxpayers just yet.
Where things get sticky is whether or not it should be the role of government to encourage borrowers into shorter-term mortgages. That, as it is looking, appears to be one of the main goals (if not the silent main goal) of the HARP II terms.
This isn't necessarily a bad business idea. Explicitly laid out in FHFA's announcement of the terms for HARP II was this reasoning:
A shorter term mortgage enables such borrowers to pay down the amount they owe much faster than a traditional 30-year mortgage. Furthermore, interest rates on shorter term mortgages usually are less than on thirty-year mortgages. The lower interest rate may provide borrowers the opportunity to shorten the term of their mortgages without much change in their monthly payments, and perhaps even a reduction in that payment. Such an outcome may strengthen the borrower’s financial condition and lower the credit risk for the Enterprise that owns or guarantees the loan.
Technically this is correct. Though the government shouldn't be needed to remind borrowers of a potentially good idea. Where there is arguably a role for government here, though, is protecting the taxpayers who are on the hook for GSE losses, and shorter-term mortgages could benefit the GSEs since borrowers would be paying their mortgages off faster, meaning they would be putting equity into their homes faster, and subsequently meaning they would be less likely to default in the future (i.e. less likely to cause losses for the GSEs, aka taxpayers.)
But refinancing from a 30-year mortgage to a 20-year mortgage is not all roses for a borrower. If the goal of refinancing is to lower ones monthly payment, that is not likely to happen with a shorter-term mortgage. If the goal is to just reduce debt, there may be interest in the option. FHFA lays out an example as spelled out in HousingWire:
[Consider] a borrower who has a $200,000 mortgage at an interest rate of 6.5% and a monthly payment of $1264. If the property is now worth $160,000, the borrower's LTV is 125%. The borrower can either refinance into a 4.5%, 30-year mortgage with a monthly payment of $1013, making it so he will not reach his balance of $160,000 for 10 years, or he can refinance into a 20-year loan at an interest rate of 4.25%, paying $1238 per month.
As pretty as that scenario looks, it still may be difficult for FHFA to convince borrowers to refi to shortened terms. Getting back to the original question at the top of the blog post though, even if they did get a lot of refinances that sped up amortization, and were widely successful within the confines of this program's parameters, what problems would this solve?
Taxpayer Risk? It conceivably may limit some losses at the GSEs, so taxpayers don't have to spend as much bailing out Fannie and Freddie. But FHFA's own worse case scenario is still well over $300 billion in losses to the taxpayers from GSE losses—which is double the current amount of bailout money paid, so I'd hardly call that a problem solved.
Household Debt? It may help reduce some homeowner debt, which is one of the biggest problems we face, but we are talking about at most a few million mortgages out of the 10s of millions underwater and millions more stuck in foreclosure. This will be barely a dent, and that is assuming that large numbers of underwater homeowners higher than 125 percent underwater participate in the program—which is far from certain.
Clearing Negative Equity? Trying to pull some homeonwers closer to the surface to avoid more underwater homes from foreclosing, HARP II is pitched as a solution. At least for those lucky enough to have their mortgage owned or guaranteed by the GSEs. But the original HARP did allow homeonwers up to 125 percent underwater to refinance and less than 10 percent of HARP refis were for mortgages with LTVs between 105 percent and 125 percent. The big question is, why was that and will the patern change with the LTV cap removed. If so, then HARP II may help some households. But it might be that it was more than the LLPA fees and putback risk holding up refis for underwater borrowers. It could have just as easily been backlogs or the lack of willingness from banks to refinance a borrower they believe will just default in the future. It also might be that many of the underwater mortgages qualifying for HARP or HARP II have second mortgages where the junior lien is holding up the refinance. It will be a coin flip at this point as to whether there is widespread participation from high LTV mortgages or not.
The program probably will appeal to borrowers that have positive equity (between 80 percent LTVs and 100 percent LTVs) and can make their payments but want to refinance to lower interest rates and avoid the fees typically associated with the refi—and that will basically mean a stimulus to them via taxpayer bailout funds to the GSEs for those lost fees. No problem solved there.
At the end of the day would a million new refis be a “big” success or a disappointment? It is all in perspective. But if the perspective is "we can’t wait," at the president is chanting, then it would be a big disappointment. Even if every qualified borrower refinanced, the impact on the housing market would be so subdued that the best case scenario here is a big disappointment, one way or the other.
What this program does not do is start the process of working the government out of the housing finance market. That would be bold action. You’re right, Mr. President, we can’t wait. Crowding out is a real thing, and the GSEs don’t appear to be going anywhere—despite the fact that even the White House agreed in February that Fannie and Freddie are unnecessary to the system.
There is a rumor that FHFA may push a pilot program to test the waters of private sector interest in mortgage finance by ordering the GSEs to sell securities with a small portion not guaranteed by the government. Of course this would have the same problem as the GSEs selling MBS before the crash—they didn't have a federal guarantee back then by law but it was assumed they did, and the same assumptions could be made here.
See my post from Monday with a full breakdown of details in the plan and list of all the possible goals of HARP II.