February 19, 2009

Breaking Down The Mortgage Bailout

President Obama yesterday announced his plan to prevent home foreclosures, saying he wanted to be "very clear about what this plan will not do: It will not rescue the unscrupulous or irresponsible by throwing good taxpayer money after bad loans . . . And it will not reward folks who bought homes they knew from the beginning they would never be able to afford."

APWe really do wish he were right. In fact, the details released yesterday suggest the President's plan will do all of the above. The plan will help some struggling homeowners. But by investing in failure, the Administration will also prolong the housing downturn and make financing a home purchase more difficult for future borrowers. Meanwhile, the plan isn't likely to slow the continuing decline in housing prices.

Let's focus on the plan's effect on the individual borrower. Anyone with mortgages owned or guaranteed by Fannie Mae and Freddie Mac will be able to refinance to lower rates if his mortgage is between 80% and 105% of the value of the home. This is a sweet deal that is not available, for example, to many renters looking to buy homes now. Sadly for those who deferred the gratification of homeownership, the 20% down payment has now become industry standard. But at least their taxes will allow other people to stay in homes they can't afford.

Existing borrowers who may not qualify for Fan/Fred refinancing can still receive loan modifications that move their mortgage payments down to 31% of monthly income. In either case, no effort will be made to verify that recipients of aid were truthful on their original mortgage applications. Given that mortgage fraud skyrocketed during the housing boom, and that the Obama Administration intends to assist up to nine million troubled borrowers, we can say with certainty that the unscrupulous will be among those rescued.

Going forward, it will be up to lenders to verify income. Getting this number correct is critical to the government's hopes for the plan. That's because, if pending Treasury guidelines follow the Federal Deposit Insurance Corp. model on which they are based, new modifications will forgo extensive underwriting. The FDIC believes that a lot of the normal research that goes into making a loan or a refinancing decision can be skipped as long as the mortgage-debt-to-income ratio can be moved, even if only for a few years, down to that magic number of 31%. So the government will pay loan servicers $1,000 for each mortgage modified, share the cost of lowering the monthly payments and pay other subsidies to lenders and borrowers -- adding up to $75 billion in taxpayer assistance for modifications. The government will then spend another $10 billion compensating lenders if the housing market continues to decline and some of these loans go bad again.

Will $10 billion be enough? The recent history of mortgage modifications isn't encouraging. According to the December report by the Comptroller of the Currency and the Office of Thrift Supervision, "The number of loans modified in the first quarter that were 30 or more days delinquent was 37 percent after three months and 55 percent after six months. The number of loans modified in the first quarter that were 60 or more days delinquent was 19 percent at three months and nearly 37 percent after six months."

Said Comptroller John Dugan, "One very troubling point is that, whether measured using 30-day or 60-day delinquencies, re-default rates increased each month and showed no signs of leveling off after six months and even eight months."

Those who favor Mr. Obama's plan say that many of these modifications haven't lowered monthly payments the way the new plan does. True, and the more taxpayer dollars are spent subsidizing a particular borrower, the more affordable a loan becomes. But in part to avoid putting an astronomical price tag on this plan, the Administration doesn't necessarily fix loans for the long term.

In fact, the program encourages mortgage servicers to keep the payments low only for five years, after which rates will rise. During the housing bubble, these were called "teaser" rates. Modifications also may extend the term of, say, a 30-year mortgage to 40 years, but still leave the borrower underwater. Research at Credit Suisse suggests that borrowers without equity are not a good bet to stay current. What research cannot answer is how many people will seek assistance when they are told that a new federal program is available to cut their mortgage bill.

Mr. Obama's mortgage plan is his third big economic rescue proposal in a month, and perhaps someone in the White House has noticed that financial markets haven't exactly cheered. Yesterday's end-of-day wrap from UBS put it this way: "Obama Speaks, Market Listens, Sells Off."

What investors, businesses and working Americans want to hear is a President with ideas to spur economic recovery. What they've been getting are plans for a long national Chapter 11 workout.

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