Real Estate
So where are we living now?
By Dan Smith

So Where Are We Now?

Some of you might be guessing Holland, except for the obvious lack of tulips, hash dens, and legal prostitution. Last week, President Obama unveiled another $275 billion initiative called the “Homeowner and Stability Plan” (HASP). $200 billion of that will go to continue shoring up Fannie Mae and Freddie Mac’s balance sheets, adding to the other $500 billion the Federal Reserve is already using currently, to buy their mortgage-backed securities (MBS). As announced to the press, this is designed to keep mortgage rates suppressed so more consumers can participate in refinancing and purchasing homes, at these historically low rates.

This first part of this new proposed bill will also remove some restrictions on Fannie Mae and Freddie Mac. This will allow some homeowners who are current, but owe up to 105 percent of the home’s value, to refinance to the current low rates being offered (and our tax dollars are paying to suppress). That would be accomplished by removing the need for mortgage insurance, as many of these insurer’s guidelines no longer serve large portions of the country. This part of the plan sounds fair enough. You worked hard and are current on your payments. But because your home fell in value, you have not been able to qualify for a refinance. The downside may be that few will be able to use this program. Unless Fannie and Freddie also agree to waive the fees associated with refinancing, most people in this category have little or no equity left to cover these costs by definition. Likewise, I am guessing they will likely be unwilling to tap their savings in this current economic environment.

It is the plans for the remaining $75 billion in direct intervention that have sparked such controversy across the country and caused one television reporter* to threaten a Boston-style “Chicago Tea Party.” But besides threatening to provoke open class warfare among U.S. citizens, there is a larger risk which has gone unmentioned so far as I can tell. And that threat is that this method may actually cause mortgage loan defaults to spike, along with interest rates themselves.

So what are these problems you are hearing so much about? Let’s take a closer look:
• This plan would allow bankruptcy judges to modify mortgage terms. The problems here are many. However, the biggest concern is the premium this could add to all other mortgages in the form of higher rates. Like credit cards, if the end investors in MBS expect the terms to be subject to change in a court proceeding, then they will demand a higher yield. That is a simple fact of life. However, the president may limit this practice to only those mortgages already in existence. That would remove the fear as it would relate to newly created mortgages and potentially stave off this investor backlash. So we will just have to wait and see.
• The biggest reason for the bankruptcy modification portion of this bill is to pressure lenders to modify mortgages for consumers currently in default and/or in the midst of foreclosure. The administration needs a lot of pressure here. That is because the president’s plan would use (our) government funds to not only subsidize the rate reduction on these loans, but also to reduce the principal balance owed. Yes, you read that correctly. It calls for reducing the payment, by either or both of these methods, to 31 percent of the borrower’s gross income. And it is this portion of the proposal that has sparked so much controversy. As the bill stands, I would agree with the absurdity of this measure. That is because there is no recapture of tax payer dollars built in here. So if “Joe Sub-prime” has his mortgage balance reduced but sells it five years from now for a profit, then we have, in fact, rewarded awfully bad behavior.
• Bankers and borrowers will also receive “pay for success bonuses.” Incentives will be paid to banks and end investors (remember the Norwegian pension fund?) for participating in these modifications of existing mortgages. Homeowners who rework their loans would also receive $1,000 per year for the next five years to encourage them to stay current. So it isn’t enough to pay off part of their mortgage and give them a 3 percent rate?

But that’s not all, and this is the obvious consequence I am not hearing discussed … yet. You see, when you announce some group of people will receive large amounts of free government money, you have a really big problem with something called “incentive.” First, if you were a bank, what would you be incented to do immediately? You guessed it—you would accelerate foreclosures as fast as possible to beat the upcoming deadline. Your goal would be to make the homes vacant as soon as possible. After all, most of these banks have already offered loan modifications, only to learn 58 percent of the borrowers re-default within the first eight months.

Second, you also incent a large portion of otherwise rational citizens to make themselves part of the chosen group receiving this free money. You guessed correctly again. Hordes of individuals will figure out how to qualify. Almost every homeowner is already paying over 31 percent of their gross income on their house payment already. Their hours at work have been reduced or they have been furloughed, etc. Then apparently all you need to do is miss a few payments once the bill passes. Sure your credit will suffer temporarily, but for some, it will be a matter of simple arithmetic versus the benefit they believe they can engineer.

*For those of you who missed it, you owe it to yourself to watch Rick Santelli of CNBC respond to the new proposal http://www.cnbc.com/id/15840232?video=1039849853&play=1  . I hope you get a chuckle out of it as I did. Lord knows we could all use one, before our 401K statements shows up again.


© Copyright 2004-2007 by ColoradoHomeLoans.com