Winners & Losers in Obama’s Mortgage Fix

by Francis Cianfrocca

Winners & Losers in Obama’s Mortgage Fix

It’s too early to figure out what President Obama actually proposed yesterday in the way of mortgage reforms. It’s not even right to call it a proposal, since we’re not getting full details for another couple of weeks. It seems like Obama is trying to lead by press release.

There are two aspects to the “plan” that are intended to generate headlines: it will supposedly make mortgage payments “more affordable” for a total of 9 million people; and it will seek to drive everyone’s mortgage payment to 31% of their monthly pre-tax income, or less.

Let’s quickly dispose of the Fannie Mae/Freddie Mac aspect of the press release. There is a provision of $200 billion to be supplied to the GSEs, for purposes of covering losses in their mortgage portfolios. This would actually be an expansion of the $100 billion that was already provided when the GSEs were nationalized back in September. They haven’t yet come near to consuming the $100 billion, so this is less than it appears to be. Still, it’s a nice headline.

It’s the $75 billion in direct aid to distressed homeowners that’s more of interest. So far there are no details on how this will work. Obviously, the taxpayers will be transferring $75 billion to someone. But to whom, exactly?

It seems to me that Obama would like you to think that he’s planning to put more money in your pocket. But judging from the uniformly-enthusiastic reactions of banking-industry executives and spokesmen, I think the money trail leads to them rather than to you.

If you’re a homeowner and you can’t afford your current mortgage, you don’t have many good choices today. You can’t refinance the mortgage because we’re in a credit crunch. You can’t sell the house and buy a smaller one because of the difference in value between what you paid on the house and its current value.

You can walk away from the house, leave the bank with a foreclosure, and go into rental housing. From a macroeconomic perspective, this isn’t an unhealthy thing to do, because it reflects the reality of lower housing values. It does, however, shift a tremendous amount of pain to the investors who funded your mortgage. Since many of those are banks, this process exacerbates the credit crisis by worsening their already-low capital levels.

You can also declare bankruptcy. At this point, the process gets very ragged, and very frightening to the banking industry. Affordable-housing advocates have been pressing to make it possible for bankruptcy judges to reduce the principal amount of mortgages to fair-market value. This discussion has a lot of moving parts, which I’ll ignore for now. But it’s nearly as bad for banks as foreclosures, and it will just as effectively reduce their capital levels. Again, that exacerbates the banking crisis.

The point to note is that Obama left a rather clear surface impression that his new plan indeed makes it easier for bankruptcy judges to, in effect, rewrite mortgage contracts to the detriment of lenders. But there actually was weasel language in the speech at this point, and the Administration has in fact signalled that it intends no such outcome.

That’s part of why bankers were so happy at the news.

So here’s what I think is going on here, although final conclusions have to wait until the President gets around to telling us what he intends to do, rather than what he wants us to think.

I think the proposal is intended to directly supplement mortgage payments for millions of people (using the 31%-of-pretax-income benchmark for mortgage affordability). There are reports that the plan will somehow facilitate refinancings at lower interest rates, which is somewhat similar in effect. If I’m right, this is effectively the same as reducing people’s mortgage payments (but not their mortgage principal amounts) to a level that reflects current market reality.

But at the same time, it keeps lenders from having to suffer the effects of that reality. This proposal sharply increases the value of existing mortgage-backed securities by sharply reducing their implied default risk. It directly transfers value from taxpayers to the owners of mortgage-backed securities.

The net effect is that we’re PERPETUATING the housing bubble by disallowing the market to clear at lower price levels. (The economic counterargument, which is not unmeritorious, is that allowing the market to clear will precipitate a deflationary spiral and a replay of the Great Depression.)

$75 billion is ordinarily a lot of money. But in this silly season, it actually isn’t a lot of money to throw into an economic imbalance that affects the whole country. If that’s all we’re going to spend on this, it’s not bad. It will allow a few unscrupulous homeowners to screw the taxpayers, and it will make Obama look good, but it won’t seriously change the economic situation. This all by itself is positive for bankers, because they’ve been uncertain whether they were the ones the Administration would try to screw.

If the program proves popular, however, look for it to expand. And if that happens, look for the fortunes of the homebuilding industry to recover.

This sounds good, but it’s very evil. We have far too much housing already in this country, the residue of the last housing bubble. If we get another one now due to government deliberately overvaluing mortgages, we’ve set the stage for yet another nasty crash in some future year.

And next time, it won’t be homeowners who will be overextended. It will be the taxpayers.