The first sign of a major plan from the Obama administration to help millions of underwater borrowers refinance out of their mortgage and avoid default appeared in the state with the fifth lowest foreclosure rate.
"Over the medium term, housing activity will stabilize and begin to grow again, if for no other reason than that ongoing population growth and household formation will ultimately demand it. Good, proactive housing policies could help speed that process," Federal Reserve Chairman Ben Bernanke said in Jackson Hole, Wyo., on Aug. 26.
A few weeks later, President Obama unveiled his new jobs bill and formally announced a plan was on its way to address the largest black hole in the middle of the economy: the roughly 11 million Americans who currently hold mortgages worth more than their home.
With unemployment still higher than 9%, most of these people are trapped in their homes. Without the ability to refinance out of negative equity and into a lower-rate mortgage or sell the property for at least what they owe, many borrowers have little choice but to ride it out as long as they can or walk away.
The Obama administration's objective is to find a way to eliminate barriers to refinance home loans owned or guaranteed Fannie Mae and Freddie Mac. Currently more than 8 million GSE mortgages carry interest rates higher than 6% — at a time when the average rate on a new, traditional 30-year fixed-rate loan reached 4.01%, the lowest ever recorded by the Freddie Mac survey.
So, with speculation rising over how the Obama administration plans to save housing and questions surrounding how risky the task may be, HousingWire collected dozens of opinions from industry experts.
The Congressional Budget Office invented its own make-believe mass refinance program designed for Fannie and Freddie loans in early September.
According to CBO estimates, roughly 2.9 million households would be cleared for a refinance for a total savings of $7.4 billion.
Advocates of this plan, such as Sen. Barbara Boxer (D-Calif.), said the government would actually be saving money on future bailouts needed to the GSEs.
The thinking is the more affordable the monthly payment, the fewer defaults the GSEs would have to endure and the fewer amount of bailouts (they already owe the U.S. $142 billion) they would receive.
But the CBO estimated such a program would avoid roughly 111,000 defaults, a fraction of the 4.25 million borrowers at least 30-days delinquent.
Further, advocates claim the money borrowers save would be pumped into the economy. Borrowers would be able to pay for more goods and services if they didn't have to spend that money on mortgage payments, and consumer consumption could possibly spur job growth.
Mark Zandi, chief economist at Moody's Analytics and a supporter of the Boxer bill (see sidebar on p. XX), said if roughly 4 million or 5 million borrowers make it through such a program, or a retooled Home Affordable Refinance Program, it could generate roughly $10 billion in discretionary spending for consumers.
"That's not going to solve our problems, but it's not insignificant," Zandi said.
Paul Dales, senior U.S. economist at Capital Economics, disagreed, pointing out the $7.4 billion in savings estimated by the CBO represents roughly 0.1% of consumption.
"Any changes to the administration's current program that would allow more households to refinance their mortgage at a lower rate would be welcome," Dales said. "But such moves won't provide a major boost to the economy or the housing market."
He also pointed out the CBO estimated bond investors would lose between $13 billion and $15 billion, more than offsetting any savings homeowners would get.
Anthony Sanders, a professor of real estate finance at George Mason University, isn't even convinced refinancing to a lower rate would stave off a default for many borrowers.
He said the minimal consumption such a program could add to the economy doesn't even take into consideration how much a borrower might save instead of spend.
"So, unless the streamlined refinancing recommendation generates more refinancing and/or greater savings per refinancing, streamlining will not generate much of a positive 'kick' to consumer expenditures," he said.
Still, the idea of a plan — any plan really — from the administration or Congress has spurred plenty of optimism lately.
In a September speech in Washington, Elizabeth Duke, a governor on the Federal Reserve board, said the financial problems America faces have evolved from subprime lending. Today, roughly two-thirds of underwater mortgages are actually Federal Housing Administration prime loans.
The challenge now is to provide a long-term and in-depth plan to stave off foreclosures and reel in a bloated housing inventory, she said.
"Regardless of how we got here, we, as a nation, currently have a housing market that is so severely out of balance that it is hampering our economic recovery," Duke said.
"Solutions aimed at righting the wrongs of previous reckless lending in the subprime market are not sufficient to tackle the scale of current problems."
Christopher Thornberg, founding partner of Los Angeles-based Beacon Economics, said a refinancing program limited to borrowers who maintained good credit histories throughout the crisis could actually be a good idea.
"If you are more than 10% underwater, you are going to get foreclosed on one way or another. It doesn't make financial sense for you to stay in the house," Thornberg said. "However, if you are 5% underwater or 3% underwater, or flat, then it makes all the sense in the world to help these folks refinance and take advantage of low interest rates. At that level, I totally applaud this. I think it's a great idea."
The general thinking is to loosen the requirements on the Home Affordable Refinance Program, known by its acronym HARP. Federal Housing Finance Agency Acting Director Edward DeMarco has acknowledged this process has already begun.
Freddie Mac and Fannie Mae refinanced 7 million borrowers since the Making Home Affordable program launched in March 2009 through June 2011. Combined with the Federal Housing Administration and the Veterans' Affairs office, that number goes to 10 million with more than $25 billion in savings for homeowners, according to Paul Mullings, a senior vice president at Freddie.
"Pick up the paper or turn on the TV and you would think nobody can refinance a mortgage, when more than 10 million already have since 2009, saving billions of dollars in monthly payments," Mullings said in an October blog post.
But HARP has helped about 838,000 underwater or barely-above-the-surface Fannie and Freddie borrowers to refinance. That's well below the initially estimated 4 million to 5 million borrowers the administration thought the program would reach — despite an extension.
"Given the potential savings to households, the relatively low take-up on this program warrants another look at the frictions that may be impeding these refinancing transactions," Duke said in her speech.
Christopher Mayer, a professor of real estate at Columbia Business School in New York who helped developed a refinancing proposal, said the previous steep drop in mortgage rates alone sparked the last major refinancing boom early in the last decade. (see related sidebar on p. XX),
From 2002 to 2003, Mayer said, average mortgage rates fell from 7% to 5.2%. The result: Within 30 months, roughly 85% of all outstanding U.S. mortgages with rates above 7% were paid off.
Comparatively, in June, 75% of GSE borrowers held rates higher than 5%, well above the market rate, Mayer said.
"Under normal credit conditions, we might have expected the bulk of these eligible mortgages to have paid off as borrowers refinanced or moved, as happened during the last refinancing wave from 2002 to 2003," Mayer said. "This suggests tens of millions of borrowers have not been able to take advantage of what should be an attractive refinancing proposition."
CHANGE 1: RAISING THE LTV LIMIT
HARP currently has a 125% loan-to-value ceiling.
The most obvious change to make if you wanted to bring in more borrowers to the program, would be to raise or even eliminate that ceiling. When DeMarco spoke at the American Mortgage Conference in North Carolina in September, this was the first change he mentioned the FHFA was considering.
Ron D'Vari, CEO of financial advisory firm NewOak Capital, doubts any program tweaks could effectively include borrowers this deep underwater. For them, he brazenly said, strategic default is the best option.
"Underwater borrowers with a job and income will be better off to not pay their mortgages and force the servicer into a modification as opposed to a refinancing," D'Vari said, adding the administration would have better luck installing more aggressive modification by writing down principal then streamlining the foreclosure process for anyone who doesn't qualify.
Carol Bouchner, vice president of regulatory affairs at the mortgage insurer Genworth Mortgage Insurance, said Genworth supports eliminating the 125% LTV limit so long as the program targets borrowers who've remained current. Genworth reinsures HARP loans without increasing the amount of mortgage insurance premium that it charges, even though its current premiums are as much as 20% higher than rates in effect when the original loan was insured.
"HARP is a program for borrowers who are current on their loans. These are not the so-called lost causes," she said. "The issue that borrowers face is that they've made their payments and continue to make their payments, but they can't take advantage of lower interest rates because of the LTV on their home."
Bouchner's comments were interesting because, according to some, even Duke at the Fed, some mortgage insurers may not agree to re-underwrite a policy even under diminished default risk.
Analysts at investment bank Keefe, Bruyette & Woods believe reducing or eliminating the limit might prove the easiest to implement, but it's not without its challenges.
"We believe that the main one is that loans above that LTV level could be considered uncollateralized so they might not be eligible for inclusion in REMIC securitizations," the analysts said.
David Stevens, chief executive of the Mortgage Bankers Association, echoed that concern.
"Raising HARP's 125% LTV requirement also could enable more otherwise qualified 'underwater' borrowers to refinance into a lower interest rate mortgage," according to Stevens.
But requirements for repackaging these loans through Fannie and Freddie and existing tax laws could pose "insurmountable constraints" on pricing any new security with mortgages exceeding 125% LTV at a level that could attract any investor interest, Stevens said.
The KBW analysts found an effective solution.
"Given the relatively moderate volume of loans that are likely to fall into this category, they could probably be retained in portfolio by the GSEs," they said. After all, according to the FHFA, only 7.4% of the 838,000 refinances through HARP so far have been on loans with LTV ratios between 105% and 125%.
CHANGE 2: ELIMINATE LLPAS
Loan level pricing adjustments are the upfront fees added to the cost of refinancing a higher-risk mortgage. Some borrowers with these risky loans face thousands of dollars in fees. As they scrape through their life savings just to make the mortgage payment they already have, strategic default begins to look like a more promising solution rather than paying the LLPA. The adjustments can add 40 to 50 bps to the interest rate for borrowers with lower credit scores, according to KBW.
Analysts at Barclays Capital said eliminating the LLPAs would have a minimal impact across most interest rates, but the higher the coupon, the higher the incentive.
"In terms of the likelihood of removing the LLPAs, it is not clear to what extent this would receive support from the FHFA," BarCap analysts said. "While on the margin it would give some borrowers a moderately higher refinancing incentive, there is a direct opportunity cost to GSEs due to a loss of fee stream, which may necessitate further support from taxpayers."
Duke said this risk-based pricing has always been standard, but getting rid of it shouldn't be a problem if the GSEs already own the risk.
"When the lender or guarantor already owns the credit risk, refinancing a low- or no-equity loan can actually reduce risk because it reduces payments and thus makes default less likely," Duke said.
Stevens at the MBA agreed, but also noted eliminating the risk-based fee could mean taxpayers, just as BarCap suggested, would have to make up the cost should the loan default.
"Reducing the GSEs' loan-level price adjustments on otherwise HARP-eligible loans would reduce borrower refinancing costs and are arguably unnecessary because the GSEs already assume the credit risk of the existing loan to be refinanced," Stevens said. "On the other hand, reducing LLPAs increase taxpayer exposure to paying for the GSEs' credit losses while the GSEs are under federal conservatorship."
Stevens suggested another option would be to streamline the appraisal process, which the GSE lender has already done at origination, and reduce other closing cost requirements to shrink the time and cost of refinancing.
CHANGE 3: ELIMINATE REPS/WARRANTY CLAIMS
It's the longest shot, and, of course, the largest impediment to a major refinancing boom.
DeMarco, in his speech in North Carolina, did suggest his office would at least consider waiving rep and warranty claims for refis in the name of helping underwater borrowers.
But to many, it seems unlikely.
In the first half of 2011, Fannie Mae lenders repurchased $4.5 billion in mortgages, up 40% from the same time period the year before. There are $9.6 billion in outstanding repurchase requests pending. By the midpoint of 2011 for Freddie Mac, lenders had repurchased $2.4 billion with another $3.1 billion still outstanding.
With many lenders, especially Bank of America, looking to avoid the risk of having to buy back more loans and the GSEs looking to avoid more risk, any waiver for repurchases seems unlikely and any lending done without that waiver appears just as improbable.
Nearly every person HousingWire talked to for this story said this was an essential cog in the refi machine and its toughest problem.
"With all that uncertainty I don't see how they could take loans without rep and warranties and without some assurances," said Stephen Ornstein, a partner at the financial law firm SNR Denton's capital markets practice. "It's unfathomable to me that they would waive them."
The KBW analysts concurred. "We think the main impediment to refinancing older loans is rep and warranty risk for the new originator. This is unlikely to be changed because waiving rep and warranty rights would increase the credit risk for the GSE."
As a result, they added, "We believe that the impact of any upcoming changes on the agency MBS market will be moderate."
Bouchner at Genworth also advocated not restarting the clock on rep and warranty risk.
"This really is not a new loan, so there is not new risk to it," she said. "If a borrower defaults due to a loss of a job after a HARP refi, for example, it likely has nothing to do with how the loan was underwritten or how it was refinanced under HARP but with life events."
The Federal Reserve's Duke noted that the risk "may make lenders reluctant to refinance loans originated by other lenders and so limits participation in the program. Perhaps competition among potential lenders could be increased if a minimum number of timely payments could be used as a proxy for sound original underwriting to relieve the liability of the refinancing lender for the mistakes of previous lenders."
Rich Andreano, a partner at Patton Boggs, floated the idea of tailoring the rep and warranty claims specific for the new program.
"For example, if the program does not require an appraisal of the property (on the basis that whatever the value is, it is all the GSEs currently have as security), then the approach would be that the originator does not make any of the standard reps or warranties regarding the appraisal," Andreano said.
BarCap analysts said it is possible the FHFA could waive the claims for borrowers with a clean payment history over the last year or two and those that originally had LTVs at 80% or below and falling house prices overtook them.
"A waiver along these lines has the potential to increase prepayment rates significantly, especially in higher coupons," the analysts said, but added a caveat.
The CBO mentioned in its report that the GSEs could potentially miss out on $100 million in rep and warranty relief under a waiver. But the analysts at BarCap say the CBO missed the mark.
"We believe that this number understates the true costs and that the claim amount would be much higher," the BarCap analysts said. "This would obviously be a factor that would lead the FHFA to pause when considering such an option."
NO MAGIC BULLET
Other Obama administration initiatives have fallen short of early promises.
The Home Affordable Modifcation Program was originally touted to reach 3 million to 4 million borrowers. It may not get to 1 million.
The Home Affordable Foreclosure Assistance Program has resulted in fewer than 13,000 completed short sales and deeds-in-lieu of foreclosure in more than one year.
And still, foreclosures are restarting, prices keep falling and unemployment remains too high. The lesson learned from the failure of these and other programs: there is no magic bullet. Even more alarming is the clarifying realization that housing may not be fixable.
"The huge housing finance trade groups have it wrong," said Edward Pinto, a resident fellow at the American Enterprise Institute.
"Their mantra is and always has been that housing equals jobs. That is completely backward: more jobs leads to more housing demand. They have it backward," Pinto said. "You never hear them say credit should be tighter, nor that Fannie and Freddie should retool their financing models."
Dick Bove, an analyst at Rochdale Securities, was just as critical of the administration up to this point. Its failure to grasp the effect of newly tightened lender requirements either through new regulation or far-reaching lawsuits from the Federal Housing Finance Agency, has dismantled the infrastructure needed to spark a refi boom.
"They love to pass laws and new regulations but they do not care nor do they understand what these regulations do," Bove said. "Then they get frustrated when the simplistic monetary theories they put in place do not work."
Others — like Beacon's Christopher Thornberg — fear, not only the potential failure of the program but its unintended consequences.
"My fear is that they will try to help people who are 20% underwater and who have bad credit records and ultimately it is going to cost the taxpayer," he said.
"We've already turned the corner. Clearly the majority of properties that are going to get into trouble have already gotten into trouble. I don't know why they are still doing this stuff. We are working through the tough times. At this point in time more policy shifts are likely to do more harm than good," he said.
Anthony Sanders said mortgage investors understood some risks when they bought these bonds, but they couldn't have anticipated the government would exercise its power to simply transfer wealth.
"Mortgage investors take the risk that frictions will increase or decrease, but they did not purchase MBS understanding that the government would unilaterally alter contracts," Sanders said.
"If the changes are limited to easing some underwriting requirements or limiting loan-level price adjustments, then those are risks that investors have assumed," Sanders said. "If the GSEs send every borrower who has a 6% or higher interest rate loan a preapproved application to lower their rate to 4% then that would be a violation of existing obligations to the investor."
While Zandi supported the scope of the Boxer bill, he admitted the administration has a limited amount of options to effectively turn around the housing market with one sweeping program.
"There's not a magic bullet," he said. "There's nothing that policymakers could do to make it a game changer. Of all the things they could do to be helpful reworking HARP would be at the top of the list."
This isn't a new concept.
In nearly every previous idea, investors, junior-lien holders, the GSEs and lenders are forced to bite the bullet in the name of righting a wrong they sparked themselves with out-of-control lending, overleveraged bets and delusional housing policies to begin with.
The difference with this step is that, for once, the administration seems to be attempting to help the borrowers who didn't also contribute to the crisis.
There are people, believe it or not, who took out a mortgage they could afford, made their payments as they witnessed Wall Street and Washington mishandle trillions of their own debts, all while watching helplessly as the value of their home dwindled.
Frustratingly, these financial and political stakeholders are the very ones attempting to help them — again.
And there appears very little agreement on how to do it — again.
-- Additional reporting by Kerry Curry, Jacob Gaffney, Jason Philyaw and Kerri Panchuk
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