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Will Federal Mortgage Modification Programs Help the Housing Market?
In yet another attempt at presidential heroism, Barack Obama will now rescue people struggling with mortgage payments by punishing future home buyers. Acknowledging that his prior acts of housing chivalry have underperformed, the president now proposes the renegotiation of rates for millions of homeowners and promises savings of up to $3,000 per year. This is an attractive prospect to anxious mortgagees in an age of high foreclosure rates. Yet for those on the precipice of foreclosure, this option will be out of bounds. Only “responsible” homeowners who have made their monthly payments will be eligible for the rate reductions.
The first question begged by this new development asks why the administration’s first initiatives were insufficient. A quick visit to its MakingHomeAffordable.gov site yields a few clues. Topping the list of programs is the Home Affordable Modification Program. HAMP’s criteria include a monthly mortgage payment in excess of 31 percent of monthly gross income; financial pressures that have caused or may cause delinquency; and “sufficient, documented income to support the modified payment.” Following HAMP is the Principal Reduction Alternative. Notable among PRA’s criteria is that the current loan must be neither owned nor guaranteed by the notorious Fannie Mae or Freddie Mac. This eliminates most conventional borrowers from contention, leaving those with FHA, VA and USDA-insured mortgages. The list goes on with eligibility standards varying according to the type of mortgage and the agency that guarantees it.
Common to all the presently active refinance and modification programs is the following stipulation: the applicant must prove regular income sufficient to support the newer, lower monthly payment. This is a reasonable request from a lender’s standpoint, no doubt. However, the newer, lower monthly payment in many cases still overwhelms the newer, slower cash-flow occasioned by unemployment or underemployment. Mr. Obama was betting that modest haircuts in principal and interest would attract throngs of Americans with distressed properties. Distressed wallets, however, prevailed. This state may lead to further frustration for an administration in search of borrowers who are simultaneously needy and “responsible”.
Still, the problem with these foreclosure prevention efforts is not in their failure to draw a crowd. In fact, it might prove worse for the American economy in general if they did so. At the core of these programs is the premise that debt exists in a vacuum. Operating from this assumption, we can conclude that reduction of debt by fiat results in no collateral loss. Housing expert Mark Calabria puts this fallacy to rest:
The error in this logic is that it looks only at one side of the balance sheet. A mortgage is one person's liability, but it is also another's asset. Lowering rates may cut monthly payments, but it also drives down payments on mortgages and mortgage-backed securities. Since you will have made mortgage investors poorer, they will, by the same logic, reduce their spending, lowering demand.
If this predicted contraction in investor activity comes to fruition, what will this mean for future homebuyers? Higher rates and further depreciation in home prices. Again, Calabria:
A mass refinancing is also sold as a cure for the weak housing market. Those looking to refinance, however, are not in the market to either buy or sell a home. In fact, by lowering their mortgage rates, you will reduce their offering price next time they look to trade up, because if the buyer faces higher rates in the future, prices will be depressed to compensate for giving up their current low-rate mortgage.
In other words, this could reduce future home prices.
The fundamental problem facing our housing market is a glut of homes, coupled with weak demand. The President's plan does not change these facts. In fact, by reducing the supply of new capital for mortgages, we run the risk of reducing the demand for housing, leading to further price declines.
A future that includes the loss of a home is a dismal – even terrifying – prospect. Macroeconomic cause and effect means little to those suffering through such nightmares. Yet for those who are charged with the economic stewardship of the country, blinking debt away like a genie is neither responsible nor effective. It is irresponsible because it is blind to its exacerbation of home value decline. Furthermore, it will depress the housing market by making future mortgages more prohibitive.