After years of falling home prices, the housing market has finally started to show some signs of life. But one idea that made the rounds last week would be a step in the wrong direction. Despite providing a quick shot in the arm for millions of homeowners, the benefits aren't enough to justify the cost -- and the long-term effects could be much more negative.
Housing and you
Millions of homeowners who bought homes during the housing boom still owe more in mortgage debt than their homes are worth. With all these underwater mortgages, these borrowers lack the home equity that gives other homeowners a bigger incentive to stay current on their mortgage payments. So-called "strategic defaults" have risen in popularity as many homeowners are willing to accept the big hit to their credit history that a foreclosure involves rather than trying to pay tens or even hundreds of thousands of dollars to make up the shortfall between the value of their homes and their outstanding loan debt.
But after half-hearted attempts to convince banks and other lending institutions to reduce the principal amounts due under mortgages -- attempts that have largely failed -- the federal government is now rumored to be considering more extreme measures. Reports last week suggested a new refinancing program that could cost as much $1 trillion over the next 10 years.
Because the talk at this point is almost entirely speculative, details are sketchy. But as a Bloomberg article set out the argument, a mass refinancing program could involve allowing anyone with a loan through a government sponsored enterprise like Fannie Mae or Freddie Mac to refinance their existing mortgages, reducing their interest rates to close to current levels around 4% for 30-year mortgages. Most important, the refinancing could happen without reappraisals or new income qualification -- making the transaction look more like a simple interest modification rather than a full-fledged refinancing.
Winners and losers
Obviously, such a program would have an immediate stimulative effect on the economy. Columbia economist Glenn Hubbard estimates that a whopping 72% of homeowners would be able to save an average of $355 per month on their mortgages at no cost to them, freeing up more than $85 billion for discretionary spending on other items. In addition, the effect in making the mortgage market more liquid would arguably help stem further price declines in housing.
In the corporate world, though, the program would have both winners and losers. Bank of America (NYSE: BAC ) and Regions Financial (NYSE: RF ) saw big gains last Thursday due to the rumored proposal, although the stocks both gave back ground after the Obama administration denied plans to implement such a program.
At the same time, mortgage REITs Invesco Mortgage Capital (NYSE: IVR ) and Annaly Capital (NYSE: NLY ) would likely see much of their interest margin evaporate with such a move, as they actually benefit from more illiquid conditions in the mortgage market as it provides them with better returns on the mortgage-backed securities that they own. The impact wouldn't be as high on Chimera Investment (NYSE: CIM ) , however, as it focuses on non-agency mortgages that presumably wouldn't be included in any GSE-centered government refinancing program.
Ignoring the problem
The core mistake with such a program, however, is that it doesn't address the real problem: the fact that the mortgages are underwater. Although giving underwater homeowners a chance to refinance would obviously make it easier for them to afford to make future payments, they'll still lack the incentive to do so. Moreover, underwater loans will still keep it very difficult for homeowners to consider selling their homes, restricting movement and making it harder for people to move to where more promising jobs are.
In the end, any real solution to the housing problem has to address negative homeowner equity. The market is already taking its own steps to deal with the problem, as short-sales and other creative solutions seem to occur with more regularity. For the government to intervene in a way that doesn't seek to eliminate underwater mortgages directly risks unintended consequences that in the long run could do more harm than good.
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