Clive Crook: Some thoughts on the housing plan

[babylonsister]

http://clivecrook.theatlantic.com/archives/2009/02/some_thoughts_on_the_housing_p.php

Some thoughts on the housing plan
Clive Crook

20 Feb 2009 04:13 am


The administration's housing plan seems well thought out. All three parts address clear weaknesses in the present arrangements.

The refinancing element, aimed at borrowers in good standing, allows Fannie and Freddie to refinance loans where the value of the mortgage is between 80% and 105% of the value of the property. Up to now they have not been allowed to do this (unless the mortgage is insured). Many borrowers in good standing have seen their loan-to-value ratios climb into this range because of falling house prices. The rule preventing refinancing at current lower rates is self-defeating from the agencies' own point of view, since it increases the chances of default. The plan puts this right--helping both the GSEs and their borrowers. (Some complain that the change only helps borrowers with loans owned or guaranteed by the GSEs. Well, yes, those were the loans affected by the restriction in the first place.)

The loan modification part is aimed at borrowers who are at imminent risk of default, and is modeled on the scheme that the FDIC has been testing and advocating for some months. An explicit public subsidy is involved--to the tune of $75 billion--which in effect will be split between lenders/servicers and qualifying distressed borrowers. Lenders and servicers get cleverly structured incentives to reduce monthly repayments to 31 percent of gross income. (Note that modifications up to now have been few and far between, and have often left repayments unchanged or higher than before, once penalties and arrears have been added back.) Lower repayments obviously lessen the risk of default.

The administration says that its scheme does not reward people who recklessly borrowed too much. This is untrue: the plan will certainly help some people who borrowed more than they should have. No doubt, it would be fairer to help only borrowers whose standard repayments (after teaser rates expired) were no more than say 30 percent of gross income to begin with, and/or who borrowed less than 80% of their property's initial value--in other words, to help only borrowers who behaved prudently, and who are now in trouble because their income has fallen. But of course this would have meant many more defaults. Because foreclosures also hurt innocent bystanders, there is a public interest in limiting them. The second part of the plan, I think, is indeed unfair and does raise moral hazard concerns--but I'd say that is a price worth paying if it stems the tide of foreclosures.

Will it succeed in doing that? It certainly gives loan modification a much firmer push than seen up to now. Lenders will not be forced to modify, but TARP beneficiaries will have to apply the guidelines, and show that they are making an effort. The new prospect of bankruptcy-court cramdowns (this requires legislation) should also help to focus minds. A standard Treasury-endorsed modification template ought to ease some of the worries servicers have about being sued by investors over unauthorized modifications of securitized mortgages. An important question is how far cuts in repayments will be achieved by interest-rate reductions as opposed to cuts in principal. Many observers reckon that principal reductions would curb foreclosures more effectively. The plan sees principal reductions as a possibility, but the incentives appear to grant that method of reducing repayments no special favors. Maybe this will have changed by the time we get full details of the plan next month.

The third part--$200 billion of new capital for the GSEs--improves Fannie's and Freddie's ability to buy mortgage-backed securities, supports the market value of those securities, and keeps downward pressure on the interest rates lenders charge mortgage borrowers. This too makes sense.

I'm sure the plan will reduce the rate of foreclosures--as compared with a no-plan baseline. How much it will reduce them, and whether that will be enough to stabilize the housing market, is impossible to say just yet. But after many months of almost total neglect, this is a big step forward.