Slowing foreclosures will help the housing market more than helping people pay mortages
The Obama Administration rolled out its much awaited foreclosure-prevention plan on Wednesday, saying it could help as many as 7 million to 9 million homeowners meet their mortgage payments. In contrast to last week's detail-light financial-rescue blueprint, the multipronged policy to shore up the housing market, announced by the President on a trip to foreclosure-riddled Phoenix, was packed with specifics. Key components include modifying the terms of delinquent loans, refinancing underwater mortgages and plowing more money into the federal housing agencies in order to keep mortgage rates low.
How effective all that will be remains unknown. No plan can change the fundamental economics of a bubble deflating or an economy stalling — of overpriced homes returning to more reasonable prices and out-of-work homeowners not having the income to make mortgage payments. What this plan does offer, though, is a series of targeted interventions designed to help specific groups of borrowers and by doing that, it's hoped, limit the knock-on damage caused by foreclosures both to neighborhoods and to the overall economy. "This will help some people who deserve to be helped," says Joe Gyrouko, a professor of real estate and finance at the University of Pennsylvania's Wharton School. "But will this stop the decline in housing prices? No." (See the 25 People to Blame for the Financial Crisis.)
The main part of the plan calls for spending up to $75 billion of Treasury's TARP funds to restructure the loans of homeowners who are behind on their mortgages or at immediate risk of falling behind. Since foreclosure is such an expensive process, most lenders are already modifying some loans voluntarily. But mortgage rewrites haven't necessarily been lowering borrowers' monthly payments by much, if at all — and people whose loans are held by investors have often been left out in the cold.
Under the new plan, servicers, the companies that collect mortgage checks, will be paid $1,000 every time they cut the interest rate on a loan to reduce the monthly payment to no more than 38% of a borrower's gross income. The government will split the cost of reducing the debt-to-income ratio further than that, down to 31%. Both servicers and borrowers will be paid up to $1,000 a year (for three and five years, respectively) for keeping the loan current.
Even though the program is voluntary, there are early signs that it might be the kick in the pants needed to get servicers to more aggressively rewrite loans. At a mortgage bankers' conference in Tampa, Fla., on Wednesday, servicers praised the incentive structure, and Jamie Dimon, CEO of JPMorgan Chase, went on CNBC to say he thought the plan would "lead to a lot more modifications." An earlier effort to spark loan rewrites proved to be a flop, but the Administration thinks this new program could reach 3 million to 4 million homeowners. The plan also includes an endorsement of the idea that Congress might change the bankruptcy code to let judges write down mortgage debt — a not-too-subtle reminder that if the mortgage industry doesn't play ball with voluntary modifications, a more imposing solution could be around the corner. (See pictures of Americans in their homes.)
In crafting the plan, policymakers had to walk a fine line between helping borrowers who have been caught off guard by tricky mortgage products and falling house prices and those who simply made imprudent decisions and genuinely can't afford their homes. In order to avoid propping up the second group, Treasury won't subsidize loan modifications that reduce the interest rate below 2%. If you can't afford a 2% mortgage, in the eyes of the government, you can't afford your house. The plan also doesn't apply to investors or people with jumbo mortgages — those, historically, larger than $417,000. Loans for homes that would be more valuable to lenders if repossessed won't get modified.
Those attempts to avoid moral hazard, though, might make the plan less effective in stemming the tide of foreclosures. "This goes a long way but not far enough," says Bruce Marks, who runs the Neighborhood Assistance Corporation of America, a nonprofit that works with servicers to restructure loans. After five years, the interest rate on modified loans can rise again, up to the industry average when the change is made, even if that pushes borrowers above the 38% payment-to-income ratio. The plan encourages but does not require servicers to make adjustments to principal balance — the generally acknowledged best way to keep people in their homes, especially when they owe more than their house is worth. In markets where home prices have dropped most precipitously or where investors make up a large portion of the home buyers, the plan will probably fall far short of having much of an impact.
But that may simply reflect the reality that there are a lot of people in homes who aren't going to be in them long term and that trying to keep them there is throwing good money after bad. The plan allocates money that implicitly acknowledges that: $1.5 billion to help displaced homeowners transition back to being renters and $2 billion to boost HUD's Neighborhood Stabilization Program, which lets cities and states deal with foreclosure fallout. (See pictures of the recession of 1958.)
In a nod to the notion that the government should do something to help responsible homeowners, the plan also seeks to help borrowers who have been making mortgage payments on time but can't refinance into cheaper loans because they've seen equity in their homes evaporate as prices have plummeted. The federal housing agencies Fannie Mae and Freddie Mac will refinance loans they hold or guarantee, even if borrowers owe more than their house is worth — up to 105% of the value of the property. The Administration figures that offer could reduce monthly payments for 4 million to 5 million borrowers.
But many of the same limitations apply to this part of the plan. Only interest payments will be lower, not principal balances. Homeowners who owe more than 105% of the value of their house — as is often the case in the worst-hit areas of the country — will be ineligible. And holders of jumbo loans need not apply. Again, that might reflect a sense of fairness — why should we help people who stretched beyond their means to buy McMansions? — but it ignores the facts that the delinquency rate among jumbo loans is spiking and that a foreclosed property hurts the value of surrounding ones, no matter the size of the house.
Finally, the plan bolsters the amount of money allocated to Fannie Mae and Freddie Mac in an effort to keep mortgage rates low and entice new home buyers into the market, since new buyers are what's needed to drive down the number of extra houses for sale. The two agencies, which financed or guaranteed nearly three-quarters of new home loans last year as private players retreated, will be allowed to hold more mortgages on their books and could eventually see additional infusions of cash from selling preferred stock to the Treasury Department — an authority granted in legislation last July. Those moves, as well as Treasury's continued purchase of Fannie and Freddie mortgage-backed securities, are designed not only to foster liquidity but also to instill confidence in the housing market.
Confidence — people believing that things are going to get better and that it's time to move off the sidelines — is a key part of any long-lasting housing rebound. It's also, unfortunately, impossible to mandate.