Doomed to Fail

Once again, the Obama administration has announced a plan to shore up housing prices and underwater homeowners—and once again the plan is very likely to fail.

This latest effort will try to use Fannie Mae and Freddie Mac, now wards of the government, to help homeowners refinance mortgages at lower interest rates.

The premise is that with interest rates at record lows, homeowners can save hundreds of dollars a month in their mortgage payments by refinancing. For example, by refinancing a 5.5 percent mortgage to a 4.5 percent mortgage, a homeowner with a $300,000 loan could save about $250 a month.

In theory, as many as 1.6 million people could qualify for this kind of refinancing, putting more money in their pockets. So this new program would be a source of economic stimulus as well as housing relief.

But the devil is in the details. Fannie and Freddie lost a ton of money in the subprime disaster. That’s why the government had to take them over. So the last thing they want to do is finance more risky mortgages.

As a result, Obama’s proposed program limits eligibility to those who have been current on their loan payments for at least six months. That excludes a lot of struggling people. The new rules will supposedly allow refinancing for borrowers who owe more than the current value of their homes, but in practice underwriters have discouraged such borrowers by throwing up other obstacles.

Thus far, the program on which the new initiative is building, the Home Affordable Refinancing Program, or HARP, has refinanced well under a million mortgages, of which only some 70,000 went to homeowners who were underwater.

So this program could turn out to have some marginal value as a form of economic stimulus, but it is not likely to bring relief where it is needed most—to homeowners at risk of foreclosure. Fannie and Freddie, as presently structured, are the wrong place to look for such relief because they are very risk-averse about incurring more losses.

HARP’s big brother, the program known as HAMP, is also a notable failure. HAMP, for Home Affordable Modification Program, is a voluntary program in which banks receive incentive payments if they agree to make mortgage modifications. The program has helped fewer than a million homeowners avoid foreclosure, perhaps one in ten of those at risk of losing their homes. Many of the homeowners who received temporary loan modifications went right back into default.

Late last year, Neil Barofsky, the special inspector general for the Treasury’s Troubled Assets Relief Program, issued a blistering report challenging the administration’s inflated numbers.

Barofsky said, “They say for example that they’ve helped more than 1.3 million people through mortgage modifications, but more than half of those have failed. Then, they go and say, ‘Well, each one of those had a significant benefit for the homeowner.’ And that’s just not true.”

All told, according to The Washington Post, the administration has spent only $2.4 billion of the $50 billion that it committed nearly three years ago to help homeowners. Why does the administration keep resorting to do-overs when it comes to mortgage relief? It all boils down to one thing. Tim Geithner’s Treasury Department keeps giving priority to helping banks.

If banks and other bondholders had to write down the value of mortgages, either whole loans or securitized loans, to their actual market value, banks and other investors would take a large hit. Geithner’s effort to prop up banks by disguising the true weakness of their balance sheets would take an even bigger hit.

When HAMP was first proposed as legislation in 2009, the administration quickly abandoned a provision that would allow a bankruptcy judge to reduce the amount of a mortgage loan to the depressed value of the home, as a way to preserve its value by allowing the homeowner to stay in the property. This would have been far less costly to society than the slow rolling wave of foreclosures—but more costly to banks.

The irony is that Fannie and Freddie, which began life as public entities, then got privatized, are now back in the hands of the government.  But the government proposes to use them only in a very gingerly fashion rather than as true public institutions.

When Roosevelt faced a similar problem of people losing their homes, in the 1930s, he created the Home Owners Loan Corporation to make direct home loans, at a shade above the government’s own borrowing rate. At its peak, HOLC had refinanced one mortgage in five. And when it wrapped up its business after World War II, HOLC actually returned a small profit to the Treasury.

If the deep economic slump lingers and Obama is denied a second term, his political epitaph will be that in the face of a deep financial crisis, he aimed too low. If he wants to aim higher, those at risk of losing their homes would be a good place to start.

It was politically brave of Obama to announce this program in Las Vegas, Nevada, the state with America’s worst foreclosure rate, where a staggering 60 percent of homeowners owe more on their mortgages than the value of their home. But the new program is not really for those in or near foreclosure. Once again, the administration is aiming too low and will very likely need yet another do-over next year.

The real source of the problem is the nation’s other Las Vegas, otherwise known as Wall Street, and the administration’s failure to fundamentally reform our system of finance. If Obama wants to show that he is with the 99 percent rather than the 1 percent, he will need to take on the bankers before he can deliver real mortgage relief.

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