Predicting the future of housing policy

August 13, 2012

Recent changes to a mortgage refinancing program finally have it running smoothly and helping “underwater borrowers”: Can Congress really ignore this?

Fannie Mae and Freddie Mac’s Home Affordable Refinance Program (HARP) helps borrowers who are underwater (and only those who are current on their payments) refinance their mortgage at lower interest rates. While it took lenders a few months to implement the changes, hundreds of thousands of borrowers have already refinanced their mortgage or are in the pipeline to do so. The new HARP 2.0  includes a pricing regime that encourages borrowers to refinance into mortgages with shorter terms, which means borrowers are building back equity in their homes faster. And that is good.

Congress just broke for its August holiday, so we will have to wait until September for the next flare-up in housing policy. However, a debate was recently reignited that leaves plenty of room for thought.

Ed DeMarco, acting director of the Federal Housing Finance Agency, decided on the last day of July against allowing Fannie Mae and Freddie Mac to write down mortgage debt for underwater borrowers. This debate is several years old – and there is perhaps no other housing-related issue that has engendered as much partisan frustration.

Treasury Secretary Tim Geithner immediately sent a letter condemning DeMarco’s decision. But as Neil Barofsky (the former inspector general of TARP) noted in a recent column for Reuters, the simple fact that Secretary Geithner chose (merely) to send a letter demonstrates that what matters most in housing these days is, sadly, politics over policy. Barofsky continues: “Although one can argue whether principal reductions are the right way to address the ongoing housing slump … no one should be fooled that the administration’s entreaties to Mr. DeMarco are anything but political posturing.” Moreover, the entire effort “seems primarily intended to distract attention from [the administration’s] own failed policies.”

As the FHFA made clear in a recent report, there are approximately 4.6 million underwater borrowers with loans backed by Fannie Mae or Freddie Mac, but  “approximately 80 percent of [these] underwater borrowers are current on their loans.” Against this backdrop, the regulator estimates that only around 75,000 to 250,000 borrowers might be eligible for a write-down. Yet it would only take a few thousand “strategic defaulters” (i.e., those who previously were able and willing to pay but who decide to stop paying to qualify for the write-downs) for the program to result in taxpayer losses. Given the sheer size of the national mortgage market, DeMarco says a new principal reduction program “would not make a meaningful improvement in reducing foreclosures in a cost effective way for taxpayers.”

It is important to keep in mind that nobody – on the left or right – wants to “own” the risk that there could be even more taxpayer losses associated with the housing bust, or accept the political fallout from angry voters who believe policymakers are rewarding others’ bad decisions.

Nick Timiraos, a reporter for the Wall Street Journal, notes how the Federal Housing Administration (FHA) should be a prime “contender for the kind of principal forgiveness many would like to see Fannie and Freddie undertake,” since it would come without the hassle of having to work through an independent regulator. Unlike Fannie Mae and Freddie Mac, the FHA is a full instrument of the administration and subject to the congressional appropriations process. If the Obama administration is such a strong believer in the economics of principal forgiveness, why would it not pursue this policy at FHA, over which it possesses complete control?

Perhaps it’s because the FHA is on the brink of insolvency – and may very well require a congressional bailout. In fact, the Obama administration narrowly escaped having to announce a bailout earlier this year. This is unsurprising, considering the FHA has $2.6 billion in reserves against more than $1 trillion in total mortgage value insured (an effective leverage ratio more than 10 times greater than Lehman Brothers at the time of its collapse), and about 31 percent of its loans are underwater.

Taxpayers have lost more than $150 billion on bailing out Fannie Mae and Freddie Mac. Those are sunk costs. But a quirk in the government budget rules, coupled with a general inaction by the administration and Congress, has allowed the government sponsored enterprises (GSEs) to remain off budget and maintain an open line of credit from the Treasury to cover any future losses. As Timiraos notes, additional losses as a result of a principal forgiveness plan “may not be easily seen” at Fannie and Freddie, and certainly not in the context of a huge number like $150 billion.

The administration and Congress will probably take a pass on trying to overrule DeMarco on principal forgiveness. It’s just too dangerous for any politician to get linked to further taxpayer losses in and around housing before the election.

While more than 1 million loans were refinanced under HARP from 2009 to late 2011 – the HARP program had long been viewed as a disappointment (e.g., early promises by the administration had the program reaching millions more). But then FHFA decided to change the program’s underwriting criteria to try to responsibly boost borrower participation.

The new volume coming in under HARP 2.0 has been very impressive since it went into effect in March. This poses questions about whether the Senate should even consider a bill by Senators Barbara Boxer and Robert Menendez (aka HARP 3.0), particularly since changing HARP rules again would slow the nascent boom as lender systems are again changed. Here are the four key stats on HARP 2.0:

  • In June 2012, HARP refinance volume was about 125,000, whereas in June 2011, it was only 28,000.
  • In the second quarter of 2012, volume ran about 243,000, versus only 86,000 during the same quarter last year.
  • In June 2012, borrowers with loan-to-value (LTV) ratios greater than 105 percent accounted for 62 percent of all HARP volume.
  • June 2012 was the first month with meaningful refinance volume for mortgages with LTVs above 125 percent; over 53,000 refinancings were completed in the month, whereas March, April and May all fluctuated around 3,000.

The narrative behind these numbers is powerful. Even the objective underlying a new measure from Senator Jeff Merkley – “faster amortization,” or borrowers choosing shorter-term mortgages – is already ramping up. While only 10 percent of borrowers chose to refinance into shorter-term mortgages under HARP in 2011, in May the number was 19 percent and in June it was 18 percent. This hurts arguments for further legislative action as well, since a bill would come with a delay for implementation and unsettle the current process, which is working.

Senators Boxer and Menendez are the key champions of expanding the HARP program. (Note: I testified before the Senate Banking Committee on this bill back in May.) Senator Merkley’s measure would provide greater incentives under HARP (perhaps with a taxpayer cost) for borrowers who choose to refinance into shorter-term mortgages, so they end up paying down their balance faster and regain equity in their homes. In many ways, this effort is an alternative to principal forgiveness for underwater borrowers.

Acting Director DeMarco and FHFA deserve more credit than criticism these days. Examining the nuances of the principal forgiveness debate, especially in the context of the new HARP 2.0, provides a solid guide for where the policy discussion is headed this fall: nowhere fast. And that’s probably a good thing for taxpayers and struggling borrowers.

PHOTO: Homeowners Jesse Fernandez (R) and his brother Joel Fernandez (C) speak with a Freddie Mac representative as they try to get a home loan modification during the Neighborhood Assistance Corporation of America event in Phoenix, February 4, 2011. REUTERS/Joshua Lott

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