Homeowner Affordability and Stability

It seems no one likes any ideas being put forth on any economic issue these days. The alternative of just letting banks, companies and homeowners just 'go under' is increasingly argued to be the optimal long-run choice. But doing nothing is a choice too. Certainly some will be worse off if nothing is done. And some maybe better off if something is done. So now we get into debates about who pays the costs and who gets the benefits, and if plan A has more impact than plan B. But doing nothing no longer seems to be a politically or economically viable choice.

Today we learn the details of the HAS plan - that is the Homeowner Affordability and Stability plan first announced in February by the Treasury Dept. The HAS plan is the newest iteration of foreclosure prevention. Round I was largely voluntary efforts by industry and resulted in some good press and the creation of a national hotline for borrowers in trouble. Round II stepped up the voluntary efforts, layered on some FHA loan products (which ended up being almost un-usable), money for foreclosure counseling and a few regulatory moves around the margin. In the end a few people in default were helped but it would be hard to prove there as much impact, beyond the efforts of the FDIC to offer loan modifications to borrowers of loans from the failed bank Indy Mac, which the FDIC itself took over.

The HAS plan has a number of components, some of which are quite vague if not innovative. But it boils down to 2 main efforts: (1) refinance underwater loans held by Fannie Mae and Freddie Mac and (2) facilitate loan modifications for borrowers "at risk".

Fannie and Freddie are under government conservatorship. They require government subsidy to operate at this point and seem willing to take on the risky proposition of refinancing borrowers who owe more than their home is worth. The catch is the borrower also has to have high payment ratios such that affording the mortgage is in question; just being in a declining home value market is not enough. It looks like the implementation of this will also require some indications of (a) hardship like job loss or income reduction and (b) re-underwriting the loan to prove the borrower can actually pay going forward. It is likely many will apply and only a fraction will qualify. And remember by definition Freddie and Fannie borrowers are better credit quality, not subprime or in the category of various 'exotic' loans.

The danger is making the rules too narrow and then no borrowers are helped. (See "Hope For Homeowners" the FHA refinance product which is the poster child of protecting a program from abuse by making the terms so strict no one could use it.) On the other end is making the program so easy to qualify for that a high share of these newly refinanced loans default. Or worse from a PR perspective, some 'undeserving' borrowers get a deal. When the guy in Miami with 3 condos slips through and gets a loan it will be sure to be in the press.

The second part of HAS is not refinancing loans but modifying the terms of existing loans. This relies on the efforts of private lenders. It is voluntary on the lenders' part, but in reality every major mortgage lender is depending on TARP or some other form of government support, so not taking part in HAS would be a poor move politically. Again details are forthcoming, but here are some components:

- payments to servicers to make mods. This addresses a major problem in the market. Even if the lender and borrower may be better off with a modified loan, the servicer may be financially better off pushing foreclosure. $1,500 may not be enough to change the calculus, but it at least forces a second look at modification options.

- cost sharing for lowering payments. Lenders are required to take a hit by lowering interest rates and/or principal to get payments to 38% of income, then split the cost with Treasury of getting payments down to 31%.

- incentives for performance. Borrowers who agree to a mod can get up to $1000 per year for 5 years for principal reduction. Not a huge amount but perhaps again it lines up borrowers to make an extra effort.

- opportunity to re-capture some revenue later. After 5 years the modification can start to increase interest rates and payments as economic conditions improve. This could prove to be a problem if the economy stays soft. Let's all hope 5 years is not overly optimistic. One could imagine this date being pushed back if so.

- insurance against further home value declines. This is the most cutting edge and least well defined. Basically FDIC insures the lender in case home values drop more and the home goes further under water.

The Treasury is releasing guidelines for modifications. The idea is to again focus on borrowers with hardships, either in foreclosure or at risk of it. Payments will be lowered and in some cases principal forgiven. This will be a 'new' kind of modification in many ways. The press has jumped on data from the OCC that shows 50% or more of mods re-default. But mods in 2008 often increased monthly payments and/or principal, so this should not be a big surprise. Alan White's recent data suggest the types of mods proposed here will perform much better, with short-run defaults of 20% or less.

Will all of this work? Compared to what? We have learned a lot in the last few months and the HAS incorporates some important lessons. A major issue remains investors in securities. There is no legal consensus on how loan terms being re-written filter up to how securities divide up losses in principal and interest payments. Lenders and servicers may still fail to offer mods because of fear of legal issues with investors.

In the short run we can count on consumers being confused. Phone lines and websites to lenders will be overwhelmed. The HOPE hotline and housing counselors like will see a deluge of clients looking to understand what they can do. It is unlikely servicers--who are already grossly over their capacity to deal with loan workouts--will smoothly launch HAS mods. And then the process for administering government subsidy to lenders/servicers on a loan by loan basis has the potential to become a bureaucratic mess (FHA has done it for years; many lenders and FHA employees will debate both sides of how well this works).

Given a stream of strongly negative data on the housing, employment and banking front, the bottom of this crisis may not yet be in sight. Let's hope HAS has more impact than its predecessors.

Update: Here are the details... More detailed than many expected... The new piece is documenting 'hardship' which clearly intends to avoid 'underserving' borrowers from getting help. Also a "1-strike and you are out" for re-default. And, an emphasis on using the FHA Hope for Homeowners loan program. Now let's watch the implementation...