The Secret Stimulus in the President’s New Refinance Program

At the end of Showtime’s new Mad-Men-cum-Californication program “House of Lies,” Don Cheadle walks a fictional version of J.P. Morgan Chase or Citigroup through a “loan amnesty program” he suggests they create. The fictional banks is looking for a way to avoid a huge stream of customers leaving. Cheadle’s consultant team comes up with a ploy that looks like an amnesty program aimed showing the public the bank cares, but really is a program designed to whittle the the 17 million customers who might apply for the amnesty program down to about just 50,000 mortgage write downs due to “initial disqualifications,” “processing,” “technical disqualifications,” from lack of follow through on the bank’s or customer’s part, and simply taking so long that an estimated 6 percent of the customers die before their amnesty kicks in. The bank looks like heroes, but doesn’t have to actually sacrifice much at all.

This is, in effect, what President Obama’s refinance program announced last night does.

Specifically, President Obama asked Congress to enact “a plan that gives every responsible homeowner the chance to save about $3,000 a year on their mortgage, by refinancing at historically low interest rates. No more red tape. No more runaround from the banks.”

One key phrase in this is “every” responsible homeowner, suggesting that the new plan will cover mortgages that are not backed by Fannie Mae and Freddie Mac. At present, banks only participate in programs like HAMP and HARP (the utterly failed refinance and modification programs started by the administration years ago) on a voluntary basis. While the details of the program are not all out on the table yet, the President suggests he wants Congress to require banks to give easy refinancing.

The other key caveat in the program is that is “responsible homeowners.” These refinances will not be available to pretty much anyone struggling to make their mortgage payment or who has fallen behind because refis are only permissible for those who are current on their mortgage (usually meaning you’ve made at least your last six months payments). So while the President puts his program in context of “lenders who sold mortgages to people who couldn’t afford them, and buyers who knew they couldn’t afford them” this doesn’t address at all borrowers who are facing foreclosure.

The program also does not change life much for those who are underwater on their mortgage. A refinance is not a modification. So even if a borrower were able to afford refinancing a mortgage that is more than the underlying home is now worth (requiring a hefty up front payment to do so because of the reappraisal), the house would still be underwater. That means when the President appeals to the “millions of innocent Americans who’ve seen their home values decline” in the paragraph immediately preceding the role out of his new program, he is also being misleading.

And that doesn’t even begin to address that this program will do nothing to help the housing industry directly. It doesn’t mean new homes to build (so, the President putting the program in context of the hard hit construction industry is deception). It doesn’t mean home prices will be more affordable for homebuyers. In fact, it doesn’t help anyone except homeowners who are already able to afford their payments in homes that are largely still valuable.

So what is this program? A stimulus program.

The program aims to put $3,000 in the pocket of every American who is already able to pay their mortgage by a forcible refinance. Since those homeowners won’t need the money to pay for their home, they can presumably use it elsewhere in the economy. Stimulus.

The problem is that even if you support the program purely as a stimulus (which many surely do), it doesn’t really help the economy on net. The money for the stimulus is going to be taken from financial institutions, mortgage investors, and even grandma’s pension fund.

Here is how: Although we don’t have the full details for the program we know the President wants to pay for it with “a small fee on the largest financial institutions.” The appeals to populism not economic rational (which is one of the more frustrating forms of politics, but we’ll leave that alone). So the initial funding to pay for the refinancing will come out of the economy through financial institutions and then put back into the economy through consumers—a highly inefficient use of resources compared to those institutions investing directly in small businesses or technology research or whatever is determined to be a good investment idea.

Certainly some will then argue that the banks are not investing in the economy right now, and we would get into a debate over whether there are not enough good borrowers out there, or if the tax and regulatory structure is creating uncertainty, and we wind up back in the same debate we’ve been engaged in for the past few years.

But we can actually step around that argument to note that the negative impact to the economy doesn’t stop with the transfer payments. Refinancing a mortgage means prepayment. And prepayment means losses to mortgage investors. I imagine not everyone is in tears over the rights of mortgage investors, but don’t forget that many of the investors in mortgages are institutional investors that were required to invest in AAA rated debt, and bought a lot of mortgage-backed securities—and many of those institutional investors are pension funds. Losses to mortgage investors doesn’t just mean losses to some fat cat on Wall Street. It also means losses to your grandmother’s pension fund which may struggle to make full payouts. Objectively we should consider all humans the same and so a forced loss to one person (the fat cat) shouldn’t be objectively more acceptable than another (grandma), but since the President is playing a populist game, it is helpful to point out the reality of what these losses mean to all participants in the economy.

Since this plan requires Congressional action, the whole thing is probably moot at the end of the day. We’ve covered elsewhere on our blog the problems with these types of programs from a technical perspective. The main critique of this program is that it is a stimulus program disguised as a program to help the housing market which actually only transfers money from financial institutions to homeowners who have been making mortgage payments while disregarding mortgage investors who include not just fat cats, but grandma too.

Read the full text of the SOTU here and search for the phrase “there’s never been a better time to build” to find the passage referencing this program.