In favor of wholesale mortgage refinance

By Felix Salmon
September 8, 2011
David Wessel and Shahien Nasiripour have similar reactions to the CBO paper on the costs and benefits of a wholesale mortgage refinance.

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David Wessel and Shahien Nasiripour have similar reactions to the CBO paper on the costs and benefits of a wholesale mortgage refinance. Both of them say the effect of such a scheme would be pretty small, especially when you take into account the fact that the government would lose $4.5 billion, and private investors another $13-15 billion, in prepayment losses. Here’s Shahien:

Some 2.9m mortgages worth $428bn would be refinanced, saving borrowers $7.4bn from lower payments and averting 111,000 defaults at a cost of about $600m to the US government, the CBO said.

But investors in mortgage-backed securities guaranteed by the US would lose about $13bn to $15bn from prepayments on securities yielding above-market rates, the economists say.

This is all true — but I think it overstates the costs and understates the benefits of this idea.

For one thing, the benefits side can easily be increased just by tweaking a few numbers. The CBO paper just says that the new, refinanced mortgages would be issued at the “prevailing market rate”, without saying what that rate is; I think they’re using a rate around 4.5% on a 30-year fixed mortgage. But agency paper is trading at much lower yields than that. If you refinance existing mortgage holders at a rate of say 3.5%, then you’ll get many more people participating, and everybody participating will save a lot more money.

What’s more, the benefits side of the CBO calculation includes the mortgage-interest savings only for the first year — as are the savings to the GSEs of having to pay out less money in guarantee obligations. But the idea here is to refinance into 30-year bonds, so the total savings are much bigger, over the course of ten or 30 years, than the numbers in the CBO paper.

Meanwhile, the big prepayment “losses” are wholly a one-off expense which will never be repeated; it’s a bit disingenuous to take one year’s annual savings, as the CBO does, and then subtract a big one-off cost in order to get a net cost to the federal government of $600 million. Why not take two years’ savings, or three, or ten?

But what are these prepayment losses, anyway? They’re calculated by taking the market value of the mortgage-backed securities backed by the mortgages which will be refinanced, and then assuming that those securities will be paid off at 100 cents on the dollar. Since the securities are trading well above par right now, around 106 cents on the dollar, anybody who marks to market would suffer a loss of about 6% on their holding.

Let me translate that into English for you: the CBO is saying that if we paid off current bondholders at 100 cents on the dollar, they would lose as much as $15 billion. Doing so is entirely legal and proper: all of these mortgages can be prepaid. And anybody buying a mortgage bond cares first and foremost about prepayment risk — this would hardly come out of the blue.

But what’s happening right now is that mortgage bonds are trading well above par just because investors are well aware that refis are hard to come by for many homeowners. They’re basically taking unfair advantage of the fact that homeowners are locked into above-market mortgage rates. If the value of their bonds came down towards the face value of the bonds, that would be a good thing. It’s not good when mortgage bonds trade well below par, but it’s not good when they trade well above par, either — it’s a sign of market failure. Remember, there would be no default involved here. So bondholders really couldn’t complain much.

One of the ways that capital takes advantage of labor in this country is the way in which homeowners who can prepay their mortgage for free often don’t take advantage of that option even when it’s available to them and doing so would save them tens of thousands of dollars. I think there are psychological reasons for this, but any plan which reduces the ranks of those homeowners is a good idea in my book.

Besides, it’s about time that homeowners who have diligently been paying off their mortgage, in full, throughout the financial crisis and all the way to the present day, should get some kind of reward from the government. This idea is a much better way of doing that than is the dreadful and hugely expensive institution of mortgage-interest tax relief. What we need, right now, is for the US as a whole to take advantage of the incredibly low interest-rate environment. Wholesale mortgage refinance is a great way of achieving exactly that goal.

23 comments so far

> One of the ways that capital takes advantage of labor in this country is the way in which homeowners who can prepay their mortgage for free often don’t take advantage of that option even when it’s available to them and doing so would save them tens of thousands of dollars.

This is false; mortgage bond pricing models do not assume rational agents, but instead model prepayment risk based on actual consumer behavior, and thus this failure to refinance is priced into mortgage rates. As such, the homeowners who (irrationally) fail to refinance are subsidizing homeowners who do refinance, not banks or investors.

Posted by dWj | Report as abusive

Economists and real people might disagree on when it makes sense to refinance?

The transaction cost of refinancing is roughly 1% the value of the loan. If you can drop your mortgage rate by 0.25%, then in theory refinancing would save you thousands of dollars — but in reality it probably makes sense to wait. Will you still own the house five years from now? Will mortgage rates drop further? Is it worth the significant time and trouble for that kind of savings?

If refinancing cuts the mortgage rate by 1% or more, it will almost always make practical sense to refinance. Any lesser savings results in excessive “churn”, with most of the savings going towards transaction costs.

Is anybody aware of an attempt to value the prepayment OPTION as an actual option? And include it in the larger analysis? What implications would that have on behavior?

Posted by TFF | Report as abusive

The bonds are trading above par because they pay a higher yield than prevailing rates and contain roughly zero credit risk (because of the guarantee). If you can show me that these bonds are priced higher than an equivalent security that does contain prepayment risk, I would be very, very interested to see that.

Posted by MitchW | Report as abusive

“But what’s happening right now is that mortgage bonds are trading well above par just because investors are well aware that refis are hard to come by for many homeowners. They’re basically taking unfair advantage of the fact that homeowners are locked into above-market mortgage rates.”


Felix, I don’t know where you got this (weird) idea but it is complete nonsense.

“Besides, it’s about time that homeowners who have diligently been paying off their mortgage, in full, throughout the financial crisis and all the way to the present day, should get some kind of reward from the government.”

Geez, Felix, another idiotic opinion. Why the heck should ‘the government’ (which is funded by taxpayers, btw) “reward” borrowers for meeting their contractual obligations?

I don’t have a mortgage; I paid cash for my house. I also have a lot of cash currently earning ZIP — for the past two years and the next two years. What “reward” do I (and folks like me) get for simply being financially responsible and fiscally conservative?!

Sometimes your analyses are illuminating; this one is rubbish.

Posted by dbsmith1 | Report as abusive

I just got an offer in the mail from BofA to refinance a mortgage that is currently about 50% of the house value and less than our family annual income.

They offer 4.5% with 2 points plus fees. NYS has a 1% mortgage tax. A break-even analysis would show about 2 to 3 years just to recoup the points, fees, and tax on this offer.

It is clear that they are only interested in re-fis where they can generate significant immediate profits. We are probably going to refinance this fall, but will probably be leaving BofA when we do unless I can get a serious offer from them.

Posted by ErnieD | Report as abusive

Only a few million people will benefit from this and it will make housing more expensive in the long run. Why not just give everyone another tax cut? I’m sorry these people have screwed up their lives and the lives of millions of others, but it is silly to think that helping a few deadbeats with underwater mortgages will suddenly rescue the country. Do we really need people to trade houses like baseball cards to keep our economy growing?

Posted by silliness | Report as abusive

The narrative here is that refis would be good for millions of folks. So why don’t these millions of folks just do it already? Waiting around for a federal government program highly unlikely to occur is counterproductive but understandable. But what is not understandable is guys like Felix pumping for it. It would be way better to get these millions of borrowers seriously planning on what they need to do to refi than waiting for the next disappointing program, whatever it may be. Do you need to bring $20K to the table? Start looking for it – or keep paying the current loan if that is the better option.

Posted by Eric377 | Report as abusive

“The narrative here is that refis would be good for millions of folks. So why don’t these millions of folks just do it already?”

Can’t refinance if you are underwater.

A friend of a friend is in this kind of trouble. He is honest and honorable — wants to pay back what he borrowed. But right now his interest rate is well above market, and he is working two jobs to make ends meet.

He *should* hand the keys to the bank and walk away. (He has a second home he is presently renting, but could move right in to.) Sure, it would ding his credit, but it would dramatically improve his financial situation.

But an interest rate adjustment would also solve his problem, and allow him to repay the full principal.

Posted by TFF | Report as abusive

US mortgage market is the only state sponsored mortgage market in the world , the mighty governement should indeed find a mechanism to allow to refinance cheaply mortgages above 100% ltv . velocity or turn around in the housing market will kick start the economy . exchange your refinancing for either your pension age , your social security retirement , your mortgage tax deduction … It may have a cost upfront , but would benefit future generations … it is really easy , but indeed , the financial lobby will oppose it as they will loose tremendous source of income (high coupon mortgages) . Ginnie Mae 5′s trading at 110 is putting most of the honorable american workers in a debt prison , guarded by the banks who got rescued by the government “of the people” .

Posted by pdf | Report as abusive

The roll of goverment must include defense of the countries citizens against external threats. The goverment should be there to pick up the peices when LA gets hit with an 8.0 or New Orleans is under 15′ of water.

I made a pretty big, and hard to reverse mistake in 2006. I bought a house near the peak of he bubble. I’m at 6% and would easily meet the credit and income requirements to get to something like 4.5%. The problem is my house value has plummeted…

… but it’s not 15′ under water and it didn’t get hit by a hurricane, a tornado, or an Earthquake. As much as I’d like my favoriate uncle Sam to give me some kind of redo on the price, or the interest rate… the simple truth is there is no reason whatsoever that my fellow citizens should collectively contribute to correct my poor timing.

Posted by y2kurtus | Report as abusive

Hey TFF – I understand your friend’s plight. If someone gave me money I could pay off my debts too. Why is your friend so much more worthy of help than me or my friends?

And he/she has two houses!!!!!! Millions of people would love to have one small house and we should help this person keep both of theirs? Lord have mercy… you can’t be serious with this.

Posted by silliness | Report as abusive

silliness, please read more carefully. He isn’t asking anybody to give him money. He wants to refinance the FULL balance at current rates. And he could successfully do so (he is managing to make the payments on his present commitments, albeit with difficulty) — except that he is massively underwater.

If the house were worth more than the mortgage, he could refinance the balance at the lower interest rate and pay off the higher rate loan. That would greatly improve his situation. But no bank will take on a new loan for more than the house is worth — it matters not that the PRESENT loan is for more than the house is worth.

Nor will his current lender talk to him while he is current on his mortgage. That is their right, of course, but he isn’t about to default on his obligations unless forced to do so.

“And he/she has two houses!!!!!!”

From what I understand (I don’t know him personally), he bought a house, then upgraded in the middle of the real estate craze and (rather than selling) rented out the old one. A stupid move, which everybody (himself included) realizes at this point.

“Millions of people would love to have one small house and we should help this person keep both of theirs?”

silliness, can you please stop making stuff up?!? NOWHERE did I say “we should help this person”. If you can’t read, then don’t post.

What I actually said was that he should ditch the underwater house, hand the keys to the bank, and walk away from the situation. (Or continue to live there, rent free, until they kick him out.) At that point he would be back to ONE house, a reasonable mortgage, and a positive net worth. The incentives that are presently in place favor that course of action.

It wasn’t a plea for help, and I don’t have a heck of a lot of sympathy for somebody who got themselves into that situation through their own stupidity. I’ve been puzzling over the incentives, though, and wondering if there can’t be a way to realign the incentives in a way that would be better for all involved. Seriously, the LAST thing the bank wants is another foreclosed house in their inventory.

He has a way out, it simply isn’t an honorable one. I don’t generally feel it is healthy for society to have incentives strongly aligned AGAINST honorable behavior.

Posted by TFF | Report as abusive

For the record, TFF, silliness is right and you are wrong (and long-winded about it to boot).

Your friend “wants” to do the “honorable” thing (be a debt slave with two houses). He’s not asking for “help” but both he and you think it would be “nice” and help “everybody” if he could be a debt slave at a lower price point.

We’d all like to get some free money. Put me down for some too. But this money isn’t free, it comes from all of us, since our money will go to prop up FanFred when it leaks cash ever faster. Well, rubbish. There’s nothing “honorable” about any of this mess. He’s just going to have to figure something out on his own, as will everyone else.

Posted by LadyGodiva | Report as abusive

@y2kurtus, being you have already stated you would walk away from your mortgage if you lose your job, I find it hard to read “the simple truth is there is no reason whatsoever that my fellow citizens should collectively contribute to correct my poor timing” when what you mean is they are suckers and you as a banker know walking away is a better strategy….

LadyGodiva silliness is just venting and wrong. He blames the homeowners when it was not the homeowners who made the bubble or brought the economy to it’s knees. While there are certainly deadbeats, he is broad brushing.

Don’t blame the homeowners, blame those who made the predicament they are in and welcome the possibility of stability, because if not there are plenty more foreclosures and more potentially underwater as the economy continues to falter.

Foreclosures aren’t exactly slowing down, they are simply being masked by some of the honest courts that value your rule of law and the procedural process. The economy isn’t going to recover until the housing situation is back on track … which won’t happen until there are more jobs so people can afford to pay their mortgages as opposed to walking or “figuring it out on his own” as you put it.

A total housing collapse will cost everyone a lot more (although that will solve everyone having a choice of what to do) and @silliness wants to give everyone a tax cut, but as Felix says, people were using their Mortgage Interest credit to balance their accounts, which makes it an incentive for more bubbles not a fix.

Letting the housing market collapse is an option, but then it won’t just be “a few million people” that aren’t presently you or @silliness needing help …

Posted by hsvkitty | Report as abusive

A big refi of underwater, income deficient debtors is really nothing more than a glorified cheap rent program, except the debtor is stuck in the property and has little mobility. No mention of any serious debt forgiveness. In medieval times this was called serfdom. Not clear to me what the economic benefits of this are.

Posted by russwinter | Report as abusive

LadyGodiva, the only reason to mention “honorable” is to explain why he hasn’t already walked away from the mess. He has a very simple and effective solution available to him — ask the tenants to move out of his former house, then mail the keys on the underwater property back to the bank. He lives in a non-recourse state, so there is literally nothing the bank can do about it. If he wanted to take advantage of the situation, he could simply stop making payments and wait (likely many months) until the bank got around to foreclosing. Living rent-free all the while. I have no particular sympathy for him, both because he created this mess for him and because he already has a (relatively) painless solution available to him.

From the societal perspective, however, I find it an intriguing puzzle. If he walks away from the loan, he is the ONLY entity involved who benefits from that decision. It would be a bad outcome for the bank servicing the loan. It would be a bad outcome for whoever owns or guarantees the loan. It would (perhaps) pass part of the loss along to taxpayers through Fannie/Freddie. And foreclosures are bad for the neighborhood/community.

Is foreclosure really the best outcome here?

Selfishly, I would also like to see these bad loans resolved more rapidly (even if some of the cost lands on me). The economy will not and cannot generate growth as long as zombies continue to trample through the financial system. Rather than face a decade or more of stagnation, I would rather take a one-time 15% haircut on my life savings and get back to a healthier situation.

Is admittedly fraught with moral hazard, however.

Posted by TFF | Report as abusive

It’s an interesting dilemma. The unfortunate truth in all of it, is that the mortgage / loan servicing mechanisms were never properly prepared for this / similar outcomes.

I’ve lost count of the number of federal programs (HAMP, HARP, HAP(less)) intended to dissuade homeowners from default / foreclosure for a rewrite on the mortgage rate or payments. Has to be at least 3, perhaps 4. If anyone here understands mortgage servicing industry, please chime in with some positive examples. Mortgage servicing was in its hey-day between 2003-2006, and with annualized housing gains of 10-15% (broadly) little work was needed to process a default/foreclosure. Since 2007, not that much. The work is tedious, and bound to have trouble attracting or keeping talent. (I’ve toured one or two sites, and visited with servicing personnel previously; processing 90+ delinquent queues would be, well, problematic one could presume).

And to perform servicing successfully, well you’d need an available, lower-salary talent base to freely tap. Small wonder many of the big players have relocated into the DFW region; whether by merger or acquisition.

Posted by McGriffen | Report as abusive

“If anyone here understands mortgage servicing industry, please chime in with some positive examples.”

Wasn’t there a private program that involved negotiating a short-sale with the bank, then renting/selling the home back to the homeowner at a reduced price?

Foreclosure is very expensive, very bad for the bank. Retaining the current loans on an underwater property is very expensive, very bad for the borrower. (Probably shouldn’t call them a “homeowner” when they have negative equity.)

Given the magnitude of the numbers involved, there ought to be a highly profitable middle ground. The interesting question to me is figuring out how to frame the solution to improve the situation for all parties involved while grabbing a profit for a third party mediator (possibly the federal government).

Posted by TFF | Report as abusive

^Perhaps that’s true. Still seems difficult to pull that off, en masse. Another means to think this through: if a given homeowner has managed to meet the mortgage commitments thus far, since mid-2007 / 2008, that’s 3+ years of making payments. Amid the housing deflation and the recession.

In some people’s minds, that would appear to reduce the credit risk (relative to the mid-2007 / 2008 timeframe. To be fair, this homeowner does not equate to getting any kind of award. But it’s apparent, to now, this homeowner example exhibited both the capacity / willingness to meet one’s obligations.

Too many of the earlier efforts were focused on the wrong subset of borrowers…last one’s in, making (very likely) the least amount required for the down payment. Those very juicy Alt-A and subprime borrowers were never really an owner to begin with, ie, if their cumulative LTV (1st lien, and 2nd lien) exceeded 110% at the time of purchase.

Loan servicing technology to do it should be cheap, and in certain areas of the US there’d be plenty of people to staff the place.

*Or go back in time, and implement a comparable RTC construct for dealing with all the badness of it. The unfortunate consequence of TARP, bailouts for FN / FRE, etc…, is that much of the delivery mechanisms just continued as is (more / less).

Posted by McGriffen | Report as abusive

FS once said: “In recent years lots of people have lost lots of money by making exactly that bet. Which would seem to indicate that a bit of prudence, and saving up money for a decent down payment, makes a lot more sense than a speculative plunge into a highly-leveraged and extremely illiquid asset.” ow-to-funnel-money-to-bankers-and-broker s-housing-edition

So it is depressing to see progressives try to recreate a failed economic model. I hope the President has the good sense to pass on this one, but if he doesn’t he loses my vote. As a renter who sat out this “silliness” while y’all made housing unaffordable for people like me, this scheme will only keep prices high. I understand why you want this option, but please don’t pretend it is going to help the economy or stimulate demand in any meaningful way. You are just guessing that it will.

Posted by silliness | Report as abusive

Did you truly believe that by “sitting out this silliness” you would be immune from the fallout? It might not destroy the economy, but we will certainly be feeling it for decades.

Falling home prices might sound good (and wouldn’t directly have any impact on my situation), but it would slaughter the banks and thus indirectly the federal government that backstops the financial system. Prices *should* fall another 30%, but paradoxically we can’t afford to allow that to happen. That is how you end up with economic zombies.

There is no hope of economic recovery while these zombies are roaming freely. You can kill them quickly through foreclosure, but you end up with the economic equivalent of sepsis. You can allow them to die slowly, but it will take a decade or more.

Do you have another answer? Please don’t pretend that we can suddenly dump the whole cost of the mess on the borrowers and banks (even if that is where it belongs). They are not sufficiently capitalized to survive that.

Posted by TFF | Report as abusive

P.S. I don’t personally care whether home prices rise or fall (we’re not moving, buying, or selling), and our mortgage will be fully paid off within three years. Maybe less. So don’t suggest I’m speaking from self-interest here.

Posted by TFF | Report as abusive

russwinter, although you have a point about the debtor being “stuck,” oddly enough having a home and that roof over your head and keeping it doesn’t feel like serfdom and certainly not a good comparison. I suppose if the housing industry stays in a slump for more than the 10 years it is likely to suffer, we could look at this again and be more pessimistic.

With your concern for the economy, you would rather see them foreclosed upon and ousted, and the home destroyed to keep the prices “stable” but still too high and obscure the market? Or is your preference the more likely scenario that that the foreclosures continue unabated, with areas becoming empty and rundown, not only decreasing the value of the homes, but all the homes in the area and threatening the town itself given there are less taxes to collect and more vandalism, property damage and fires. ( there are a plethora of other snowball effects) How has that been working so far for the economy?

If would be good to have a solution that isn’t ripe for banks to collect more fees, and offer new inroads to corruption and fraud, as in the past. There is no easy fix, but a preference for all would be that the banks take the hit this time, and pay for the damage they caused.

@TFF I am actually waiting to see how the Insurance for the homes was done and who benefited from the foreclosures. It would seem that while people are clamouring to get the foreclosures on track and the banks are whining about how they are losing money, their insurance and returns say otherwise and often the taxpayers are the ones on the hook through FM$FM.

The majority of cost of foreclosure is also passed on to the Insurer, TFF. Do not feel sorry for the banks… there is a lot of the untold story that this HAS to now been highly profitable for some banks, servicers and many other parties perhaps incollusion. There is still that shoe that should have dropped by now, but the “saving” of FM&FM means that dirty little secret may never be known.

You really do have to think that if important documents were being robosigned thousands of times and hour by several different people at just one firm, how many other “paperwork problems” were swept under the carpet to ensure we don’t rattle the markets?

@silliness I knew you weren’t a homeowner by your posts … but good for you for sitting it out and not getting caught up in something you can’t afford. However,you are blaming “us all” because you aren’t sure where to affix the blame. Maybe you need to start reading a few of the hundreds of books about the recession and what caused it, rather then blaming “us’n” or Obama…

Posted by hsvkitty | Report as abusive
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