Breaking Down the White House’s Not-So-Mass Mortgage Refinance Plan

Last week, I wrote a commentary for noting, in part, that the White House and Congress had largely failed to address one of the biggest problems with our economy: the housing market. Congress has been completely impotent, other than including QRM and QM guidelines in the Dodd-Frank Act, which make matters worse, and the repeated extension of the first-time home buyer credit, which only stole demand from the future as all gains in housing starts, permits, and price were quickly wiped out as soon as the program ended. About the only good thing Congress has done is the non-action of just letting conforming loan limits decline on schedule so that the private sector has a little bit more room to compete with the GSEs.

So the White House has tried to save the day.

The White House has tried a few programs, including the Home Affordable Modification Program that is viewed by almost everyone as a failure. And even with historically low mortgage rates, there have been only limited refinances and modifications as the cost of those actions and the fact that many don’t qualify with mortgages that are underwater, while others don’t qualify with bad credit histories, employment troubles, or backlogged banks. In the process of initiating and failing many modifications and refis, the White House programs have just dragged out the foreclosure process and added to the shadow inventory of homes, meaning we have a number of years left of downward pressure on prices instead of having just dealt with all the pain up front. But since there is little likelihood that housing finance reform will get through Congress anytime soon, the calls for something to be done have been reaching a fevered pitch lately.

So the White House is going to try again to save the day again.

The new plan, announced by FHFA this morning and set to be championed by by President Obama today at a campaign stop in Nevada later today, aims at clearing away the roadblocks to refinances. Here are the basic terms of the plan:

  • Whereas borrowers could only refinance if their homes had an LTV of 125 percent or less (i.e., owing $125,000 on a home that has fallen in value to just $100,000), now borrowers can refinance regardless of the value of their home.
  • Most borrowers will not have to get an appraisal before their refinance, a proess that takes time and costs money, as long as there is a “automated valuation model” that can help the GSEs determine a current value for the home.
  • Removes “certain risked based fees” (see LLPA) charged by Fannie Mae and Freddie Mac, cutting some of the costs that had made refinancing unattractive. It appears that most of these waived fees will come for those refinancing into mortgages with shorter terms (i.e. from 30-yr to 15-yr mortgages).
  • Borrowers must be current on at least their previous six payments (i.e., no recent deadbeats).
  • Loans with LTVs below 125 percent will be eligible for refinancing under the new terms by Dec. 1, 2011. Loans beyond 125 percent of the current value of the home won’t be eligible for refinancing until early 2012.
  • Banks would receive buy-back waivers on any mortgages refinanced.
  • All of the details of the new initiative are really changes in the structure of the Home Affordable Refinance Program (HARP), already established in 2009, and the expiration date for HARP will be extended through 2013.

A major catch in this plan is that is only applies to mortgages that are owned or guaranteed by Fannie and Freddie. That is why the White House, which runs the quasi-nationalized GSEs via FHFA, can do this without Congress.

How many families will be able to refinance?

  • According to a FHFA official cited in the Wall Street Journal, between 800,000 and one million more borrowers will be able to refinance through this new initiative. A Reuters report suggested it could be as few as 600,000.
  • For some perspective, the first refinance program called HARP has helped refinanced 894,000 mortgages by giving compensation to banks (well short of the initial goal of 5 million). While that is basically the same amount as estimated in this program, only 70,000 of HARP participants have been underwater and that is hoped to change with this revamp of HARP.
  • There are an estimated 15 million homes that are underwater and 11 million of them have LTVs higher than 110 percent. Yet, the CBO and MIT estimate that at most, roughly 3 million borrowers would participate in the expanded program.

CoreLogic estimates that 20 million borrowers with equity remaining in their homes (so not underwater), could cut at least a percentage point off their mortgage (i.e. 5 percent to 4 percent) through refinancing if made affordable. Ultimately, the GSEs back about $5 trillion of the $10.4 trillion in mortgage values currently outstanding. That means there is wide potential, but it appears there is a very narrow target with this plan. Also, only mortgages that have not been previously refinanced through HARP or were purchased before June 2009 are eligible.

Why might banks be in favor of this program that would skip around their own bureaucratic troubles?

  • Currently, Fannie and Freddie are trying to force banks to buy back loans that have gone bad, claiming the mortgages were misrepresented in quality and character. There have already been billions in buy backs, putting toxic debt back on bank balance sheets. And banks that do refis through this program would become potentially liable for a buy back request on the mortgages refinanced (if the claim isn’t already there). So to answer this problem, the plan has a waiver where mortgages that are refinanced through this HARP extension would become ineligible for the GSEs for force banks to buy back, reducing potentially tens of billions in liability (if not more depending on the ultimate scope of the program). It is unclear whether the financial industry will jump at this waiver, but if they do it could be perceived as a gift to the banks from the White House.

Why might the financial industry be against this program?

  • The program is voluntary for financial institutions to participate in as well, so some may argue there isn’t any reason to be opposed to this. It would have been much worse of the plan was a mass-refi program forced on banks and borrowers alike. But that does not mean this program comes free of costs. Every time a borrower refinances, the investor in that mortgage (whether wholly owned by a bank or in pieces through MBS) loses out on future, anticipated revenue. Refinancing creates a new mortgage, so part of the process is paying off the old mortgage, and since that payoff is coming earlier than the full term of the mortgage, the investor is losing out on interest that would have been accruing had there been no prepayment. So there may be general opposition for the investors standing behind some of these mortgages to more refis even with the new terms and the waiver for banks.

A deep unintended consequence from this is that future investors in mortgage-related investments (MBS, covered bonds, etc) will likely be scared off by the willingness of the government to push this program, as the upside to their investment will be severely tempered. And that might make it harder for the housing finance industry to come back. But whether the White House cares all depends on their goals and metrics of success. That leads us to the money question.

What is the ultimate goal of the program?

  • Shock and awe? Unlikely, given how small the scope (just GSEs) and scale (600,000 to 1 million mortgages) is on this plan. There has been a lot of hype about the White House releasing a big plan, and this really will come off as a big disappointment because of its limits and may not get much political value.
  • To substantively reduce debt? This will lower payments for the limited few that meet the new terms, but even that will not substantially reduce the massive household debt load in the U.S. A much better plan would be for banks to adopt a short-refi plan or just process the foreclosures that are going to happen anyway and write off the debt as a loss.
  • To boost the economy? Macroeconomic Advisers estimated last week that even if all 37 million mortgages at the GSEs were refinanced down to today’s rates, at most “such a plan might boost GDP growth by 0.1 to 0.2 percentage point(s).”
  • To help borrowers who are paying their mortgages and have equity in their homes? No, these households can largely refinance already, and this program would basically just be making it cheaper for them, acting sort of like a stimulus via Fannie and Freddie (which are taxpayer bailed out on a quarterly basis, so it would be general taxpayer money funding cheaper refis for households already eligible and capable).
  • To help borrowers how are paying their mortgages but don’t have equity in their homes? This could be seen as a goal in the plan, especially since the major policy change is to allow GSE backed mortgages with LTVs above 125 percent to refinance. But remember that underwater homes with negative equity have already been eligible for HARP, just up to 125 percent. How many of the HARP refis have been in that category? As we noted up above, less than 10 percent. This does not create confidence in the potential success of the extended program, though it may be a goal of the administration.
  • To help borrowers who have equity in their homes but are delinquent? No, since you have to be current on your mortgage to qualify. But even if they were included, a borrower with equity is much more likely to be able to sell their home and do it quickly since there is not a high reservation price needed to cover an underwater mortgage. The program wouldn’t really help those families if it were extended to those who have missed payments.
  • To help borrowers who have negative equity and are also delinquent? Most of these borrowers are seriously delinquent and have more problems than just their monthly mortgage payments. They range from deadbeats who were just refinancing or selling every few years before a subprime mortgage balloon payment hit to those who have lost their jobs and couldn’t afford a reduction from $1,500 a month to $1,200 a month, any more than they could afford it reduced down to $300 a month.
  • To just “Do Something”? A program with this limited scale and lack of bold action (either in the wrong or right direction) seems to be just designed to show the White House is capable of at least doing something. Bold action the wrong way would be listing to requests for mass mortgage modifications. Bold action the right way would be for the White House to read their own report on housing finance reform that says we need to shut down Fannie and Freddie and let the private sector take the lead.

In summary, the White House plan is to make homeowners with mortgages over 125 percent of their home values eligible for refinancing as long as they are current and their mortgage is lucky enough to have its investors backed by Fannie or Freddie or just by the GSEs (which, by the way, the status of is completely outside borrower control). But ultimately this mortgage program is really aimed at a small group of people; it isn’t clear that it will have much impact at all on the whole of the housing market; and it appears to be aimed at doing something on housing just for the sake of action.

The Wall Street Journal has a 12-point FAQ on the refis you may be interested in here.

Here is the press release from FHFA on the program.