The problems with Barack Obama’s proposed Homeowner Affordability and Stability plan are several. The first problem is that the $75 billion proposal is, in fact, a $475 billion proposal: $75 billion to subsidize the renegotiation of mortgages and a $400 billion capital injection into Fannie Mae and Freddie Mac, the government-sponsored enterprises at the center of the housing market’s troubles. The bill cannot be evaluated without taking into account its actual price, which turns out to be nearly six-and-a-half times the figure currently on Washington’s lips.
The second problem is the structure of the program itself. Obama proposes to shore up Fannie and Freddie, and to encourage mortgage companies to renegotiate terms for four to five million homeowners by offering lenders a bounty of up to $1,000 for each mortgage modified, along with monthly payments running into thousands of dollars over several years, for as long as borrowers remain current on their obligations. Under current standards, mortgage lenders cannot refinance a loan if the outstanding debt exceeds 80 percent of the house’s value. President Obama proposes to undo this prudent standard and allow refinancing for up to 105 percent of the house’s value, so that “upside down” borrowers will be eligible to participate. This will produce mortgage-backed securities based on debt that exceeds the value of the underlying assets and is a recipe for further instability.
So, cui bono? Put simply, this program is designed to benefit Fannie and Freddie shareholders, not the great majority of Americans struggling with their mortgages. The only loans that can be restructured are those held in Fannie/Freddie portfolios or securitized by the twins. Just in time to benefit from a refinancing boom, Fannie and Freddie plan to raise their fees to as high as 3.5 percent on April 1. (Note that date, taxpayers, and ask yourselves who is being played for the fool.) And only a tiny slice of homeowners will be eligible — those who are in relatively weak positions (house payments exceed 31 percent of gross income) but not too weak (house payments do not exceed 38 percent of gross income) and who are, despite their mortgage difficulties, still creditworthy enough to pass bank underwriting standards. Fannie and Freddie get new capital, new income, and better loans in their portfolios. Most homeowners get nothing, and taxpayers get the bill. Fannie and Freddie, which ought to be disbanded, will survive to continue distorting both markets and politics.
A third problem with this plan is that it relies on a financial calculation that may prove to be mistaken. President Obama argues that his approach will prevent foreclosures in numbers sufficient to arrest the slide in real-estate prices. But foreclosures are only one wound in that bleeding market. The other factors are arguably more meaningful and less tractable: Houses were overvalued to start with, there is a glut of supply on the market, fewer Americans are looking to buy a first house or to upgrade to a more expensive one, those who are shopping for houses have less access to credit than they did a year ago and must pay more for it, and the broader economic downturn has many Americans looking to pay down existing debts and hesitant to take on new ones. The effect of preventing some foreclosures at the margins will probably be overwhelmed by these deeper economic tides. And President Obama probably is overestimating the number of foreclosures that would be prevented in any case: Historically, about half of the homeowners who renegotiate failing mortgages end up defaulting under the new terms.
Given that lower house prices help as many people as they hurt — every transaction has a buyer and a seller — house prices probably ought to be allowed to continue declining on their own schedule, but here supply and demand run up against politics: First-time homeowners tend to be younger and less affluent, and to have less political influence, than longtime homeowners. And neither group is as politically connected as Fannie and Freddie, the actual beneficiaries of this plan.
Refinancing mortgages may be a good idea, and there is, in fact, a refinancing boom under way, a consequence of historically low interest rates. The relatively small group of in-deep but creditworthy homeowners who could be helped by Obama’s plan already are positioned to refinance at better rates, or to move from variable-rate loans to low-drama fixed-rate mortgages, without a $475 billion government intervention. Many of them already have done so. With that in mind, Obama’s proposal solves few problems, if any, and has the potential to create many new ones, as other government attempts to manage the real-estate market reliably have done. Obama says he believes in “what works.” This doesn’t.