Thursday, April 1, 2010

The Permanent Mortgage Crisis

Original posted in the Wall Street Journal:

Last Friday the White House announced its latest plan to prevent mortgage foreclosures, and earlier this week the famous Case-Shiller index found mostly flat home prices in January with analysts warning about a new wave of foreclosures to come. You can't blame the latest proposal for that outcome, but what about the previous 10 or 20 federal housing rescue plans?

We're supposed to believe that this latest effort to build an artificial floor under home prices will perform better than the Hope Now Alliance announced by President Bush in October 2007;

  • better than the revised Hope Now program announced two months later;
  • better than Hope for Homeowners, which was passed by Congress and signed by Mr. Bush in 2008;
  • better than the foreclosure moratoriums promoted by Fannie Mae, Freddie Mac and Representative Barney Frank into early 2009;
  • better than the $127 billion that taxpayers have thus far poured into Fan and Fred, much of it for foreclosure relief;
  • better than the Federal Reserve's purchase of $1.25 trillion in mortgage-backed securities;
  • better than last year's expansion of the 2008 First-Time Home Buyer Tax Credit to up to $8,000;
  • better than the billions in stimulus dollars that have been spent "to restore neighborhoods hardest hit by concentrated foreclosures," according to the White House;
  • better than the $1.5 billion announced earlier this year to state housing finance agencies in the electorally hard-hit areas of Arizona, California, Florida, Michigan and Nevada, and $600 million more this week for other states certified as political disaster areas;
  • and certainly better than Mr. Obama's year-old Home Affordable Modification Program to offer mortgage modifications to troubled borrowers or his companion program to offer generous refinancing. We could go on, but you get the joke, even if the housing market hasn't.

Here's a heretical thought: What if Washington had simply let housing prices fall on their own to find their natural bottom? The pain would have been more severe more quickly for some owners who bought more expensive homes than they could afford. But the pain might also be over by now as housing markets cleared faster, and housing might be contributing to a healthier economic expansion.

Instead we are heading toward year five of the housing recession, with Washington proposing even more ideas to prolong the agony. One senior banking regulator we talk to calls it "extending and pretending."

But how long can troubled borrowers even pretend? The latest Mortgage Metrics report from the Comptroller of the Currency shows that most of the loans modified in the first quarter of 2009 had gone bad again within nine months—52% were more than 60 days delinquent.

The highlights of the latest plan are increased incentives for banks to reduce mortgage principal for troubled borrowers, reduced mortgage payments for unemployed borrowers, more regulatory barriers for banks wishing to foreclose, and a new ability of underwater borrowers to refinance into taxpayer-backed loans from the Federal Housing Administration.

Watching its previous failures, Team Obama will now emphasize reducing principal instead of merely lowering monthly mortgage payments for some years. The White House no doubt noticed that many of the loans modified outside of the various government programs—with aggressive principal reductions—had better re-default rates.

But this doesn't mean that such reductions are always a good idea. Many of these private reductions were the result of legal settlements, not business decisions. Obviously if taxpayers chip in to provide equity to millions of underwater borrowers, the borrowers will have less incentive to default. But how many more borrowers will be motivated to seek assistance when the subsidies become more generous?

A lower mortgage bill is surely a relief to an unemployed worker, but what he really needs is a job, and we see nothing in this plan (or any other Washington scheme) to encourage job creation. To the extent that these payments are merely unemployment benefits laundered through the mortgage system and thus reduce incentives to find work, the jobless rate will stay higher for longer and the entire economy will be worse off.

Potentially the most expensive part of this plan for taxpayers is the new Federal Housing Administration refinancing option. (Yes, that is the same FHA that is already struggling under mortgage losses and announced last year that its capital had fallen below the level required by law.) Taxpayers will be required to stand behind a "homeowner" who owes mortgage debt equal to 115% of the value of the home and whose monthly mortgage bill is up to 31% of total income. Message to owners who borrowed responsibly: Next time, don't be such a sap.

You'll also be pleased to know the Administration says the price tag on this latest housing plan won't exceed the $50 billion already earmarked for mortgage relief in the Troubled Asset Relief Program. Just don't expect it to end the mortgage crisis.

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