The Obama Administration's Housing Proposal

Here are the facts on the new housing plan (The Homeowner Affordability and Stability Plan, aka The Mortgage Affordability Plan) that I was unable to provide in our last session.  I have tried to include links as citations.  I hope that its intuitive which link is the trunk for which statements.

If you don't want to read, just watch these:

The Whitehouse position can be found in an Executive Summary, Fact Sheet, Housing Example Sheet, and Q&A document. (PDFs; see also www.financialstability.gov)  The speech in which Obama introduced the plan, on Feb 18, is a good summary.  (Feb 18 speech in Phoenix)  Concrete, detailed commitments are hard (impossible) to find.  Details seem to be promised for March 4. 

To abstract away from the already abstract explanations:

• The total cost could reach $275 billion.  (WSJ)
• "Every American will benefit" if "we act boldly and swiftly to arrest this downward spiral."  The Plan intends to do this by benefiting responsible families who are underwater or nearly so.  Ultimately, as many as 9 million homeowners may receive assistance.  (WH Blog; Shaun Donovan) 
• The "downward spiral" is essentially presented as: responsible buyer makes purchase --> economic turbulence --> job loss/illness --> depressed home prices --> no ability to sell at profit or refinance --> cut back spending to make mortgage payments --> spend savings --> default --> foreclosure --> house prices nearby drop 9% --> failing local businesses --> lost jobs--> repeat --> credit crisis --> job crisis --> repeat--> doom.  (Feb 18 speech)
• Shoddy lending practices, speculation, and excessively-large-home-purchasers do not appear in the narrative because the will not be rescued by the plan.  (id)
• There are four prongs laid out in the speech:
  • Refinance 4-5 million mortgages received "through" Fannie and Freddie
    • Currently F&F cannot refinance mortgages worth more than 80% of the value of the home.  This cap will be removed.  The WSJ reports that the new cap will be 105 percent.
    • The cost to taxpayers will be zero.  F&F get less cash, but that is balanced out by a reduction in defaults and foreclosures.  Foreclosures reduce neighboring house prices by up to 9%, and this plan will save the average homeowner $6,000 in averted loss of home value.  (Executive Summary)
  • Incentives to lenders to modify sub-prime loans at risk of default
    • Subprime loans make up 12 percent of all mortgages but almost half of foreclosures.  Renegotiation is complicated by many factors.
    • The plan will establish "clear guidelines for the entire industry" that will be a pre-requisite to receiving government aid. According to the Executive Summary:
    • • The monthly payments will have to be less than 38 percent of the borrower's income (from an alleged present high of 40-50 percent), and the government will make up the difference to the bank on any further reductions down to 31 percent of income.
      • Servicers will receive $1,000 cash up front for each modification.  They stand to make a further $1,000 over three years if the modification is successful.
      • If the loan is reworked before the borrower falls behind, the servicer will get $500 and the mortgage holder will get $1,500.
      • Borrowers will get $1,000 each year for five years as deductions from their principal if they stay current on their payments.
      • "To encourage lenders to modify more mortgages and enable more families to keep their homes, the Administration -- together with the FDIC -- has developed an innovative partial guarantee initiative. The insurance fund – to be created by the Treasury Department at a size of up to $10 billion – will be designed to discourage lenders from opting to foreclose on mortgages that could be viable now out of fear that home prices will fall even further later on. Holders of mortgages modified under the program would be provided with an additional insurance payment on each modified loan, linked to declines in the home price index."
    • Treasury will develop the actual guidelines with FDIC.  They will apply to F&F and other government organs.  (Executive Summary)
    • This will facilitate 3-4 million restructurings, at a cost of $75 billion. (Executive Summary)
  • Keep mortgage rates low
    • "Today, most new home loans are backed by Fannie Mae and Freddie Mac, which guarantee loans and set standards to keep mortgage rates low and to keep mortgage financing available and predictable for middle class families.  This function is profoundly important, especially now as we grapple with crisis that would only worsen if we were to allow further disruptions in our mortgage markets."  (Feb 18 speech)
    • Through its existing authority, the Treasury will spend up to $200 billion on F&F mortgage-backed securities to "stabilize markets and hold mortgage rates down."
      • This could very well hurt the economy.  (WSJ)
    • Treasury will purchase preferred stock to the tune of $200 billion in EACH.  That figure is double the current cap per ex-GSE.  (Although, it seems they may not be near even the current maximum, WSJ)
    • F&F will get larger retained mortgage portfolios, up from $850 billion to $900 billion.
  • Reforms designed to keep families in their homes
    • Cramdown reforms
      • These might be counterproductive by damaging the value of mortgage-backed securities.  (WSJ)
      • The Administration has not been clear on exactly what this will look like, or why it is necessary.  (WSJ)
    • $2 billion for innovative community solutions
    • Require strong oversight (ES)
    • $1.5 billion in relocation assistance to renters displaced by foreclosure (ES)
    • Reform FHA programs (ES)

Loan modifications have not been succesful as of yet.  In fact, nearly half have raised or left unchanged the costs of the mortgage.  (WSJ)  The guidelines for loan modification should be available next month.  Provisional details include:

• Homeowners who can afford their mortgage payments will get nothing.
• Mortgage companies will have to verify income and hardship claims.

The WSJ provides a quick review of reactions:

• Critic say the plan:
  • rewards homeowners who used their house like an ATM
  • relieves homeowners who bought houses far outside their means
  • incentivizes everyone to apply for aid.  In fact, Wells Fargo reported a 20% increase in calls about refinancing on the day after the plan was announced.
  • buyers will stop paying their mortgages just to get help because of the 38 percent (payment:income) of income cut off for eligibility
  • homeowners with substantial assets but moderate incomes may be able to slip through the cracks
  • wrongfully pays $1,000 annually to homeowners who stay current on their modified mortagages
  • redistributes income away from those who acted responsibly (WSJ) (Mean Street)
  • won't actually do any good because of re-default rates and the absence of long-term fixed rates for reworked loans (especially good: WSJ)
  • does nothing to deal with reworking securitized mortgages (WSJ)

• The Administration counters that:
  • It is impossible to help a large number of people without some over-inclusion and moral hazard.
  • The plan tries to make help available before homeowners are seriously delinquent or in default by incentivizing mortgage companies with cash rebates on modifications for "at risk" homeowners.

• Other benefits include:
  
  • Banks using "net present value" to calculate the losses on a modification relative to foreclosure should screen out borrowers who took on more than they could afford.
  • Not everyone who is in mortgage-related trouble was an irresponsible borrower.  Anecdotes abound about people who had the rug pulled out from under their economic position.

Politicians have taken predictable positions.  Although, the Republican counter-position is oddly un-Republican and distressingly reminiscent of the F&F debacle.

Will this plan help the right people?

• As many as 14.8 million homeowners may be unable to refinance because they have less than 20% of the value of the home in equity.  But, only F&F mortgages get relief from this predicament.  (WSJ)
• $14.1 million homes nationally are worth too little relative to their mortgage to qualify even at the 105% level.  (WSJ)
• Hard-hit states like Florida, California, and Arizona will not get much help because housing prices have fallen too far.  (WSJ)
• Wealthy borrowers with jumbo loans are shut out of the refinancing process because F&F cannot handle loans of that size.  (WSJ)
• The plan does not fix loan terms in the long-run, so when the teaser rates expire after five years, we might be right back in the thick of it.  (WSJ)
• Demand for these subsidies will rise to meet the supply, and the line drawn to limit supply here was arbitrary and divisive.  (WSJ)
• The Economist questions whether or not the problem is that people cannot pay or that they are not willing to pay.  The answer, the editors conclude, will determine whether or not the Administration's new plan is effective.  If negative equity, and the incentive to walk away, is the problem, then tinkering with interest rates will not solve the problem.

Oddities:

• If you add up all the numbers, they don't work.  According to the Executive Summary, 6 million homes face the risk of foreclosure.  Yet, as many as 9 million people will be helped by the plan, hopefully.  Presumably, 5 million through F&F and 4 million through reworking mortgages.  Is this not just like a stimulus, but consciously part of the stimulus effort?  Like paying too much for toxic assets in order to give banks liquidity?
• This is complication, not a refutation, but it seems slightly tenuous to tout the benefits for the economy from putting more money in consumers' pockets by allowing them to refinance/restructure when that money is coming out of bank balance sheets.  (See WSJ)  Now, maybe everyone will be in a net positive position relative to the status quo and foreclosure.  Maybe its better for consumers to have the money because of the (presumed) multiplier.  The real answer has to be that tax dollars will be used to make sure that there are no short-term losers.  This really is just stimulus by another name.  Lets hope that Ricardian equivalence does not hold.
• Is any government policy that needs celebrities to sell it a good idea?  I think not.
• Real estate speculation seems to be joined at the hip with deficit spending, all the way back to the days of Andrew Jackson.

Data:

* Ruth Simon and Carrick Mollenkamp, Proposal is Heavy on Incentives to Modify Loans, WSJ.com

The WSJ reports that Minnesota Governor Tim Pawlenty (R) says that the housing plan rewards irresponsible behavior and that homeowners should have to restructure their finances in bankruptcy before the government steps in.  Pennsylvania Governor Ed Rendell (D) admits that the housing plan rewards bad behavior, just like the Wall Street bailout, but warns that the alternative is a systemic failure.  Whose right?  No one knows, not even Mr. Harmon.