Obama Administration Housing Initiatives

1
Obama Administration Housing Initiatives

• Douglas J. Elliott
• July 2, 2009

2
Agenda

• The problem
• Alternative solutions
• Approach of the Obama Administration
• Progress report
• Issues for the future

3
The Problem

• Delinquency rates on mortgages are very high and
  rising
• House prices have plummeted by 32 from their
  peak and are forecast to fall further
• 19 of mortgages are underwater. 1 in 10
  borrowers were underwater by at least 10 as of
  the end of 2008
• Unemployment rate is 9.4 and will likely peak
  over 10
• As a result of these factors, a high proportion
  of delinquent mortgages are likely to default

Sources SP/Case-Shiller Composite-20 Home Price
Index Moodys Economy First American Corelogic
Bureau of Labor Statistics
4
Delinquency rates are very high and rising
Source Mortgage Bankers Association National
Delinquency Survey, seasonally-adjusted 30-day
delinquency rates Alt-A loans are split between
prime and subprime based on self-reporting by
survey respondents
5
House prices have plummeted by 32 from their peak
6
Some alternative solutions are undesirable or
appear infeasible

• Directly intervene to raise house prices
• Very expensive
• Hard to implement
• Works against market forces finding a new
  equilibrium
• Subsidize income of borrowers
• Very expensive
• Raises fairness issues

7
Infeasible Solutions, contd

• Let foreclosures occur and cushion the rest of
  the economy
• Foreclosure process is expensive, traumatic, and
  damages confidence in the economy
• Toxic assets tied to mortgages are very difficult
  to handle
• Public and politicians demand relief for
  homeowners to balance bank rescues
• Force the mortgage holders to restructure the
  loans
• May violate the takings clause of the
  Constitution
• Securitization makes implementation difficult
• Would probably damage already-weakened banks that
  rely on government aid
• Difficult for the government to determine the
  right restructuring formula

8
Main alternatives center on subsidizing
restructurings

• Both the Bush and Obama Administrations
  subsidized mortgage restructurings
• Interest subsidies are designed to deal with cash
  flow problems of homeowners
• Subsidizing principal reductions
• Would get at true solvency issues
• Would create economic incentives for those whose
  mortgages are significantly underwater

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One potential nightmare What if homeowners start
behaving rationally?

• Homeowners generally try hard to hang onto their
  homes, even when their mortgages are underwater
• Recent FRB Boston paper found that less than 10
  percent of a group of homeowners likely to have
  had negative equity eventually defaulted on their
  mortgages
• There are likely to be four main reasons for this
• Desire to preserve credit ratings
• Wanting to remain in their family home
• A desire to do the right thing, avoiding the
  shame of foreclosure
• Value of option on future price appreciation of
  the house

Sources Foote, Christopher, Kristopher Gerardi,
and Paul Willen. Negative Equity and
Foreclosure Theory and Evidence. 2008 FRB of
Boston Public Policy Discussion Paper No. 08-3.
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Nightmare, contd

• But, we have never had so many homeowners so far
  underwater on their mortgages
• What happens if the culture and environment
  change?
• Credit providers may stop giving as much weight
  to foreclosures.
• Worse, individuals may stop feeling virtuous for
  continuing to pay on underwater mortgages and may
  start to feel like fools when they see neighbors
  just turning in the keys

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Make Home Affordable Program

• Refinance
• Homeowners with conforming loans with up to 105
  Loan to Value (LTV) ratio can refinance at better
  rates
• Modification
• Lenders, servicers, and borrowers given
  incentives to lower monthly payments to 31 of
  income
• Lender reduces payments to 38 of income,
  government matches further reductions to 31
• First, through interest reduction, then longer
  amortization, then principal reduction
• Pay for success Servicers get 1,000 for each
  modification, and additional 1,000 per year for
  3 years if borrowers stay in program

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Make Home Affordable, contd

• Additional incentives for borrowers to stay
  current
• 1,500 for borrower, 500 for servicer if
  modification is made while current
• 1,000 principal reduction for borrower each year
  for 5 years if they stay current
• Servicers are encouraged to pursue alternatives
  to bankruptcy (deeds-in-lieu, short sales)
• Servicers get 1,000 for successful D-I-L or
  short sale
• Borrowers get 1,500 for relocation costs
• Judicial cramdowns of principal in bankruptcy
  proposed
• Industry-wide guidelines specified to reduce fear
  of lawsuits and clarify restructuring process

13
Progress Report

• It is too early to assess the effectiveness of
  the plan
• 14 servicers, including major ones, are signed up
• About 50,000 trial mortgage modifications have
  been performed, out of long-term target of 3-4
  million
• Roughly 100,000 applications have been received
• At the least this is better than the ONE loan
  modified under the earlier Hope for Homeowners
  plan

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Issues for the future

• How many loan modifications will be done? Biggest
  risk may be that interest rate reductions alone
  are insufficient to motivate enough homeowners,
  if solvency is the real issue
• What will the redefault rate be? Earlier programs
  involving interest rate reductions alone had a
  poor record, but they had often resulted in
  HIGHER monthly payments through fees and rolling
  past unpaid interest into principal
• Will principal reductions be essential? It
  appears that principal reductions make more of a
  difference, and may be the only way to deal with
  mortgages that are significantly underwater.
  However, lenders and servicers have been
  reluctant. Sharing in future appreciation may
  help, but is complicated

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Issues, contd

• What can be done for homeowners with Option ARMs
  mortgages? Their interest rates are already low
  at this point, so interest rate reduction has
  little effect in the near-term
• What can be done for the unemployed? They need
  more help now, but may be able to make mortgage
  payments again later on. Unfortunately, targeting
  the unemployed could have undesirable labor force
  effects