Obama's Homeowner Affordability and Stability Initiative

The President announced and Treasury published details of a new Homeowner Affordability and Stability Initiative today.  The press is struggling to get the details correct. Here is the basis of the Initiative. To be eligible, a homeowner must have defaulted on his/her mortgage payments (due to economic distress or limited income)  or otherwise hold a mortgage that is "underwater" (there is no equity left in the house once the mortgage obligation is subtracted).  If mortgage owners on such mortgages reduce mortgage payments to 38% of income of the mortgage payee (with reductions on interest and/or principle) for five years, the government will match, dollar for dollar, further mortgage payment reductions to 31% of mortgage payee income.  Treasury would also kick in a "partial guarantee" payment to the mortgage owner for a "reserve" in case the property further declines in value.  The mortgage reductions are standardized under a program to be announced March 4th and the standardization will provide "legal cover" to mortgage "servicers" that act for investors in a mortgage pool and provide guidance to the many government agencies that hold or guarantee mortgages.  All mortgage owners that take government payments under the Initiative must use the program conditions.  The cost of the Initiative is projected at $75 B.

The Initiative comes with a host of modest but significant cash grant incentive payments to mortgage owners to modify mortgages and to mortgage payees to discourage defaults on the eve of modification requests and after modifications have been accepted.

A second part of the plan is designed to help homeowners who have less than 20% equity left in their homes (but do not owe more than 105% of the homes value) and are current on payments.  They can qualify for Fannie and Freddie guarantees if they refinance--remortgage.

The back-end of the Initiative is interesting.  If the program is to the benefit of mortgage owners as well as mortgage payees, then the value of outstanding mortgages should increase once the program starts.  Yet the government is also increasing by $200B, a program to purchase preferred stock issued by Fannie Mae and Freddie Mac.  The government will also buy Fannie and Freddie MBSs through its TALF program.  In other words, the government is pouring money into Fannie Mae and Freddie Mac to support the mortgage modification program because it believes private investors will not.  Why not?  If the Initiative increases the value of outstanding mortgage portfolios, Fannie and Freddie should not need the new funds.

Will it work?  No.  Our real estate problem is and has been that cheap credit (under market interest rates) produced a bubble in real estate prices.  Housing prices in the problem markets have yet to fall enough to new equilibrium level. They have another 5 to 10% to drop.  The market needs to bottom before it stabilizes and returns to modest growth.  Artificially holding up housing prices, as this plan does, will post phone for a short period but will not stop the market from seeking an accurate bottom.  The delay will increase the pain, not mitigate it and there will be new class of suckers, who bought on the way down.