Homeowner Affordability and Stability Plan: Finding a way forward.

I like the idea behind this plan. (You can find the fact sheet here) The Administration clearly wants to help homeowners and is taking steps to do so. The plan is creeping closer to the foreclosure mitigation plan I put forward in this post. I think the plan is net positive for the housing market and that it will help, on the margin. However, the initiative does not solve the fundamental problem that is leading to foreclosure: A large (and growing) number of homeowners are underwater. That is, the amount owed on the mortgage exceeds the market value of the house net of transaction costs.

Underwater households are by far the most at risk of foreclosure. They are at risk for two main reasons. 1. At some point as the value of the home falls, the homeowner is better off defaulting on the mortgage than continuing to make payments. Households in this category are clearly at risk for imminent default. 2. Underwater households are very sensitive to income shocks. If they lose their income for any reason (health, layoffs, wealth losses), they have to default. Had they not been underwater they would have had the preferable option of selling the house. (Preferable because they lose the house either way and with the sale they may recoup some losses and avoid a default judgment.)

Rewriting mortgages such that the payment is affordable (under the household’s current income) solves neither of these problems. A household that cannot afford their current house should be encouraged to move to a house they can afford. It’s not pleasant, it’s not popular, but it is still true. And, there are very few cases where a 1 or 2 percentage point change in the mortgage interest rate will make a true difference between foreclosure and affordability. (Think of the success rate of mortgage modification to date. See my comment here.)

Here is my comment on the plan point-by-point. (Actually, I just comment on the parts that strike me as particularly good or particularly bad.):

Neighborhoods are struggling, as each foreclosed home reduces nearby property values by as much as 9 percent.

I would really like to know the source for this statement. I believe foreclosed properties have a negative impact on house prices. However, empirical studies have difficulty identifying such large effects. Take a look at this recent study by Calomiris, Longhofer, and Miles. This paper is carefully done and is representative of the literature. They find a statistically significant but small independent effect of foreclosure.

Enabling Up to 4 to 5 Million Responsible Homeowners to Refinance

I have no problem with this provision. The Administration wants to allow homeowners who already hold loans guaranteed by Fannie and Freddie to refinance at today’s rates. They are willing to relax the 80 percent down payment rule to make this happen. The only cost to this program is a potential reduction (and a possible increase) in the profitability to the two GSEs. On paper, the institutions are taking on more risk because they now hold low down payment mortgages, but in reality the risk was already there.

This aspect of the plan should have a modest positive effect. Essentially, we are transferring $2300 (the Admin’s number) from Fannie and Freddie to each of the 4 million homeowners. For the absolutely most marginal borrower, this might make the difference between foreclosure and ongoing payments.

A Shared Effort to Reduce Monthly Payments: … the lender [is] responsible for bringing down interest rates so that the borrower’s monthly mortgage payment is
no more than 38 percent of his or her income. Next, the initiative would match further reductions in interest payments dollar-for-dollar with the lender to
bring that ratio down to 31 percent.

Again, reducing payments does not necessarily lead to a reduction in foreclosures. Plus, I suspect, without having the data in hand, that most foreclosed households have had a bigger shock to their income than can be accommodated by an adjustment in interest. Unemployment insurance is not going to cover a very big mortgage payment.

Lenders will also be able to bring down monthly payments by reducing the
principal owed on the mortgage, with Treasury sharing in the costs.

Here is the one sentence in a 2300 word document on principal reduction. The details of the implementation are critical here. Reducing principal is nothing if it is only done to help make payments affordable. Reducing principal is only effective if it moves households back above water. Again see my comment here.

"Pay for Success” Incentives to Servicers: Servicers will receive an up-front fee of $1,000 for each eligible modification … They will also receive “pay for success” fees … of up to $1,000 each year for three years.

The payment reduction part of the plan is intended to serve 4 million households. $4,000 times 4 million households is $16 billion or 21 percent of the $75 billion allocated.

Incentives to Help Borrowers Stay Current: To provide an extra incentive for borrowers to keep paying on time, the initiative will provide a monthly balance reduction payment that goes straight towards reducing the principal balance of the mortgage loan. As long as a borrower stays current on his or her loan, he or she can get up to $1,000 each year for five years.

This is just a transfer and a poorly designed transfer at that. I plan to pay my mortgage (unless my house value falls a lot). I would be glad to get $5000 for doing what I do now. But keep up with the math. This is an additional $20 billion, we are up to 48 percent of the total allocated money in just these two “throw away” lines.

Home Price Decline Reserve Payments: ... 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.

$10 billion dollars is not even in the right ball park to actually insure these loans.

Supporting Low Mortgage Rates By Strengthening Confidence in Fannie Mae and
Freddie Mac

Here I will simply note that the Administration is spending more than 3 times its total homeowner initiative to work a backdoor support of the housing market.

So, in the end, although I think the plan has many positive aspects. It will not help the mortgage market much.