A Look Inside the Foreclosure Rescue Plan

In this piece I take a look at the Obama administration foreclosure rescue plan, which has three primary elements:

Underwater Mortgage Refinance: the basic idea is that Fannie (FNM) and Freddie (FRE) will refinance mortgages (provided they're that are current yet underwater, as part of an effort to give homeowners on the bubble a bit more breathing room payment wise. All that's really happening here is that the Obama administration is simply changing the rules as far as the mortgages the mortgage GSEs are allowed to refinance.

The good thing about this part of the plan is that it won't cost the taxpayers anything, and it will probably help some homeowners stay in their homes. Especially those who are primarily suffering from issues related to temporary income loss as opposed to affordability issues.

However the issue with this plan is that it assumes the inability to refinance/falling housing prices are the reason for homeowner ABC having trouble with their mortgage, as opposed to them having bought a house they couldn't afford in the first place. It's a fairly common theory, article after article on the housing crisis has cited inability to refinance as the reason a particular homeowner is facing foreclosure. In instances where a homeowner has an abnormally high reset rate on an ARM that may be true, however let's not forget that many people used ARMs to spend above their means (many banks even marketed them as a way to "afford more house") so even at a fixed rate the house wasn't necessarily affordable.

All of this leads me to believe that the efficacy of this component of the plan may be limited at best, because people who need to refinance a fixed rate mortgage in order to avoid a default are on very shaky ground in the first place.

Loan Modification Guidelines: based on some initial work done by the FDIC the Treasury will issue a set of guidelines for banks to follow when it comes to modifying mortgages, and every bank receiving TARP funding will have to implement a mortgage modification plan. Since we already know that mortgage modification is largely futile, there isn't much sense in discussing this one in greater depth.

$75 Billion Mortgage Stability Program: I saved this part for last because it is (in my view) the worst part of the program, and regardless of the spin is nothing more than a taxpayer subsidy for people who took on more than they could chew.

Here is an overview straight from the horse's mouth:

(From the WSJ): "For a sample household with payments adding up to 43 percent of his monthly income, the lender would first be responsible for bringing down interest rates so that the borrower’s monthly mortgage payment is no more than 38 percent of his or her income. Next, the initiative would match further reductions in interest payments dollar-for-dollar with the lender to bring that ratio down to 31 percent. If that borrower had a $220,000 mortgage, that could mean a reduction in monthly payments by over $400. That lower interest rate must be kept in place for five years, after which it could gradually be stepped up to the conforming loan rate in place at the time of the modification. Lenders will also be able to bring down monthly payments by reducing the principal owed on the mortgage, with Treasury sharing in the costs."

Can someone please tell me in what Universe does a responsible middle class individual take on a mortgage with a payment that's 43% of their gross monthly income? Even with the subsidies reducing the payment down to 31% of their gross monthly income, it's still a situation that isn't necessarily sustainable since common sense guidelines are more along the lines of 22-28%. How can the Obama administration claim that their foreclosure rescue program is designed to help responsible homeowners, when they're going to be forking over billions to people whose monthly payment are as high as 43% of their monthly income?

Better yet how would this program help the people who had very affordable mortgages yet are facing foreclosure due to job loss? If you had a mortgage that was in the 22-28% range and are now facing foreclosure due to being laid off, this program does nothing for you. Despite the fact that these are the very people we should be helping if indeed we're going to put taxpayer money behind keeping people in their homes.

How is that fair to the millions of people whose mortgages have payments that are below 28% of their gross monthly income, how is it fair to the people who don't need help, middle class renters, etc? Personally the only way I would be willing to stomach this plan would be if the banks were going to be required to foot the bill in the end.

The other elements of this portion of the program involved incentive payments ranging from $500-$1,500/yr for borrowers, servicers, and mortgage holders related to reaching borrowers before they get into trouble, helping people stay in their homes, making payments on time, etc. There will also be a $10 billion fund established to compensate mortgage holders for declines in housing prices, as a way to incentivize them to avoid pre-emptive foreclosures on homes that are dropping in value.

I.e. more taxpayer money thrown at not only irresponsible borrowers, but irresponsible lenders as well.

Now I understand that this plan will undoubtedly help people who are just facing foreclosure due to job loss, however let's not forget that the default rate for prime fixed rate mortgages is barely above historical norms. Meaning that the majority of the people who need mortgage help are those who took on exotic mortgages, spent above their means, etc, so despite the administration's claims they are indeed helping irresponsible borrowers.

I guess they just have a new definition of what that means.

Efficacy wise I suspect the program will be a moderate success due to the amount of cash the administration is willing to commit to keep people in their homes, it's hard to fail when you're committed to creating an artificial situation where failure isn't possible. However there are a couple of issues that keep it from being out an outright success:

Exotic Mortgage Holders: the main problem with many exotic mortgages is that the person can often only afford the teaser rate payment, the credit card like minimum payment on their option ARM, the interest only payment, etc. As a result bringing the payment down to 31% may not help someone who is in a negative amortization situation, and 31% may still be higher than the teaser rate payment they started out with.

Income Issues: between the loss of employment, the worsening economy, etc, the homeowner may not have that much to bring to the table as far as mortgage payments, and 31% may be just as untenable as 20%.

5-yr Duration : someone who is way over their head as far as being able to afford their house in 2009 is probably going to be in the same situation in 2014, especially given the situation around employment, companies cutting merit raises, etc. As a result it stands to reason that a lot of the effort to keep some of these people in their homes will be wasted, since they're likely to be in the same situation five years from now.

Final thought(s):

Foreclosure Moratoriums: many banks suspended pending foreclosures in the hope that the administration's foreclosure rescue plan would provide "something", which would allow them to avoid having to foreclose on people. However aside from the part about "modification guidelines" there is really nothing in this plan to prevent these pending foreclosures, after all if loan modifications would've worked in these situations many of these people wouldn't be facing foreclosure in the first place.

SO what happens next for these mortgages? Another round of modifications?

Overall the plan seems based on the idea that an inability to refinance, a falling housing market and loan terms are the key reasons behind the rise in foreclosures. It doesn't really seem to acknowledge that every day families did indeed make irresponsible choices, and seems to have (instead) decided to take the tack that the only irresponsible ones were the speculators. While there is some truth here I don't think you can come up with an effective remedy to the foreclosure problem until you accept that it's actually a necessary part of a needed market correction, and accept that the key problem is affordability.

I suppose you could also argue that it's based on some of the wrong ideas around housing that created this mess, namely the idea(s) of "housing at any cost", and being a "mortgage slave" is better than renting comfortably, but perhaps that's a discussion for another time.

You can read about the plan in detail here.

Sources:

The Wall St. Journal: "Obama's Plan Aimed at Helping Troubled Homeowners" -- February 18, 2009.

Disclosure: at the time of publishing the author didn't own a position in any of the companies mentioned in this article; the ideas expressed are solely the opinions of the author and shouldn't be viewed as financial or investment advice.

Comments

[User 283977:]

"Can someone please tell me in what Universe does a responsible middle class individual take on a mortgage with a payment that's 43% of their gross monthly income?"

You are of course correct, if the family income was constant. But the economy is way down and a lot of people are loosing their jobs with little prospect of getting a replacement job anytime soon. So if a family has two salaries, and one of them gets laid off...

That is how it could happen…

Feb 18 07:46 PM

[Edgar The L...:]

"Loan Modification Guidelines: based on some initial work done by the FDIC the Treasury will issue a set of guidelines for banks to follow when it comes to modifying mortgages, and every bank receiving TARP funding will have to implement a mortgage modification plan. Since we already know that mortgage modification is largely futile, there isn't much sense into discussing this one in greater depth"

Actually there is a great deal to discuss here, the "futility" of modification is misleading because so many completed modifications are done in correctly. If strident and thoughtful guidelines are implemented it is possible that this could be the biggest and best part of the solution.

Feb 18 08:19 PM

[DawnFred:]

Im in a chapter 13 and having to work two FT jobs to maintain my home. Why arent other people doing the same thing. My house payments are 1600.00 per month. I have no college degree and doing the best I can. Why is goveernment going to pull everyone out of this. Why can't people do the right thing like I am doing. Will the stimulas plan help me in anyway. I have 18 months left on the Chapter 13...will I be able to refinance and get a better house payment as well as a better interest rate and not have to do another 30 year loan. I have been in my home for 9 years. i don;t want to have to start over. Anyone have any ideas, please email me [e-mail]

Feb 18 08:26 PM

[Lonniep1:]

This is the first TARP item that I believe will actually turn things around. It is correctly aimed at the huge number of us that are in need. Why? Rates are low enough now to make a large reduction in the family housing allowance. But, the inability to refinance because of a lowered property value, or a lowered income because of family economic changes continues to trap people.
Reducing the monthly payment will give more money to other types of spending. That should provide other people and businesses to sell and earn more profit. That will provide more working incomes that can purchase things, which provides more positive attitude changes, and ultimately, a revived economy.
A key point is that refinancing is not losing money, it is paying off a higher rate loan, and borrowing at a lower rate. That is a sensible thing to do. The problem had been that the governments rules had prevented this from happening except in good times, and for only people that were doing well. This will help those not doing well to improve. Think of the credit card banks. They have someone bounce a check or miss a payment, what happens? They raise the rate to an amount that is worse than the corner bookie. B of A charges 28.99% in many instances. Is that wise? Not if you want to keep your customers. So who is getting paid off here?

Feb 18 08:54 PM

[User 341089:]

A perfect example of an irresponsible buyer


On Feb 18 08:26 PM DawnFred wrote:

> Im in a chapter 13 and having to work two FT jobs to maintain my
> home. Why arent other people doing the same thing. My house payments
> are 1600.00 per month. I have no college degree and doing the best
> I can. Why is goveernment going to pull everyone out of this. Why
> can't people do the right thing like I am doing. Will the stimulas
> plan help me in anyway. I have 18 months left on the Chapter 13...will
> I be able to refinance and get a better house payment as well as
> a better interest rate and not have to do another 30 year loan. I
> have been in my home for 9 years. i don;t want to have to start over.
> Anyone have any ideas, please email me [e-mail]

Feb 18 08:58 PM

[mathdummy:]

Qustion for the math geniuses:

For a homeowner whose income has decreased, changing the monthly mortgage payment to 31% of income (without changing # of payments or $ pricipal) could result in a negative interest rate. Right?

"How woud you like to pay for that house? $300,000 cash or 30 annual payments of $8,000 each?" They wouldn't do it with their own money, but of course, it's not their own money, it's ours and we don't care. Right?

Feb 19 02:03 AM

[TeddyBearNeil:]

Why am I paying for my neighbors Vacation/Cruise to Hawaii/Bahamas, their multiple trips to Vegas and their new BMW, exotic chandelier and other high priced

furniture in their home?

Here is the story of a friend who bought a New home in Tracy, CA in January, 2004.

The cost of the home at that time was 350K. I paid 20% down. My neighbors also bought the same model at the same time with a 3% down payment.

They refinanced into a 3/1 Arm cash out with a low teaser rate in November, 2005 for 500K because the value of the home had gone up. I did not do any such

thing and just continued to pay my mortgage. They quickly spent the money on buying the exotic chandelier and other high priced furniture in their home and

went on a Vacation to Hawaii and then on a Cruise to Monte Carlo. In between they had time to party out in glitzy Vegas.

In 2008 their first re-set took their payment way above what they could afford and they are behind on their payments. The current value of the home is back

to what it was valued in 2004 - 350K.

Now, per some of the advocates of foreclosure prevention, a principal write down (from 500K to 350K) is going to be handed out to my neighbor by the

government using my tax dollars, so that he can continue to pay the same monthly payment as me after having run through 150K of Tax payer money! Thus forcing

me to pay for my neighbor's luxuries?

Both of us have teenaged kids. I did not indulge in any of the splurges that my neighbor indulged in. I drive around in my old Ford Taurus, saved money equal

to 8 months of living expenses just in case I lose my job and put away some more in a CD so that it could help pay for my kids college tuition fees!

Feb 19 08:35 AM

[Don Kamp:]

Re: Plan for underwater mortgages.

Let me get this straight: The plan is to take underwater loans and have then refinanced and guaranteed by a supposedly private GSE company (I'd rather call them a Government Manipulated Enterprise) who they (Fanny and Freddie) themselves are deeply underwater. In the very next paragraph you say that luckily this won't cost the tax payers any money. What kind of koolaid have you been smoking! It reminds me of someone digging a hole so deep they will never get out. So let's just keep digging. What the hey...

Don Kamp
Canajoharie, NY.

Feb 19 09:39 AM

[Don Kamp:]

I agree. This solution is just one big shell game. Our new administration is failing to take a direct approach (Bad Bank) and instead is so afraid of this mess that they are more inclined to dictate their ideals on private enterprise. They already know it's bound to fail and want to keep as distant as possible from the fallout. Originally Paulson and Geithner were both keen on the direct approach, but were put on a short leash by career politicians.

I wish we had a politician who would say, "I want to help with these current difficulties, but I don't want to make this my career. Just give me 4 years. I am so confident that I can resolve this crisis, I will reduce my pay by 50% each year until things begin to turn around". What about Lee Iococca?

I think that Obama is showing that he is about an ineffective as FDR was. He's prone to do a lot of fiddling and side-stepping, spending and manipulating, but the results will be similar: We're looking a long hard decade ahead with just enough of a glimmer of hope to keep us in severe economic bondage yet still plodding forward. Don Kamp.


On Feb 18 08:19 PM Edgar The Lender wrote:

> "Loan Modification Guidelines: based on some initial work done by
> the FDIC the Treasury will issue a set of guidelines for banks to
> follow when it comes to modifying mortgages, and every bank receiving
> TARP funding will have to implement a mortgage modification plan.
> Since we already know that mortgage modification is largely futile,
> there isn't much sense into discussing this one in greater depth"
>
>
> Actually there is a great deal to discuss here, the "futility" of
> modification is misleading because so many completed modifications
> are done in correctly. If strident and thoughtful guidelines are
> implemented it is possible that this could be the biggest and best
> part of the solution.
>

Feb 19 10:41 AM

[axelrod608:]

Do the math. People paid $ Trillions more for their homes than they're worth now. Worse, they bought them with time bomb mortgages. The potential losses are staggering - many $Trillions.

The problem with saying, "let the irresponsibles who got themselves into this mess pay" is that they have created a systemic downward economic spiral that affects EVERYONE. We all pay. The country pays.

And worst of all, Wall Street packaged all those time bomb mortgages and sold them all over the world. So in effect, the entire world is paying.

The ONLY way out is to "eliminate" foreclosure. The piddling little being applied to the mortgage crisis - the major factor in the national economic downward spiral - will be ineffective. If the federales don't do something radical in that area, the downward spiral will persist.

Reducing mortgage payments by a few percentage points of income will not stimulate spending. All the current programs are a product of inside-the-box thinking.

Have the government pay off mortgages in full as foreclosures happen, taking a lien of up-to the amount it costs to pay it off. The lenders are made whole - no loss to write off and plenty of money to lend again.

Let the people stay in the house. They would be barred from taking out any equity loans on the property. With no mortgage payment, they will start spending again. Some payment plan should be started if they are still in the house after a period of time. Those payments would go directly to pay down the cost of the program.

When the home sells, the government gets the net up to the amount they bought the mortgage for.

This is the ONLY way to stem the tide of foreclosures. There are millions of ARM's out there that will be resetting well into 2012. They will be a continuing source of new foreclosures wel into 2013 unless "foreclosure" is eliminated. And the only way to make the financial sector whole is to pay off those mortgages.

Eliminate foreclosures or they will persist for another five years, and all the other related problems will stay with us as well.

Feb 19 10:42 AM

[nova:]

Obama plan undermines the basic free market principles promoting irresponsible behavior, welfare dependency and fraud.

The consequences for the US society are obvious: economic collapse and social unrest. The money to support this Obama plan will come from viable and successful businesses and US$ printing presses.

It is very sad situation for US taxpayers with very negative consequences for US economy and social stability.

Feb 19 01:17 PM

[kurt walter:]

This latest bailout plan will not work. What will work? Foreclose and sell the property a auction to the highest bidder. The sooner this is done, the sooner the mess will be fixed.

Feb 19 01:51 PM

[EJR:]

If "you" are the one that needs this mortgage, then may I suggest if you ever have extra money to pocket each month - please DON'T spend it. Save it and stop taking on something you are not prepared for. Nowhere in your mortgage contract did it say your house would not go down in value.

Please don't spend your newfound money that I, and every other responsible taxpayer is GIVING (strike that, that is being redistributed) to you. For God's sake, I don't want to have to pay for your credit card bills a few years from now or your retirement because, wow, guess what, the market went down or inflation errodes the value of your investments because we are so deeply in debt paying for irresponsible people's mistakes!

TAKE SOME PERSONAL RESPONSIBILITY FOR CRYING OUT LOUD!

YOU fix your problem - get another job, get a better job. Sell some of your stuff you don't need. Anyone who owns a cell phone or has cable tv and looks for a government handout is an absolute leech.


On Feb 18 08:54 PM Lonniep1 wrote:

> This is the first TARP item that I believe will actually turn things
> around. It is correctly aimed at the huge number of us that are in
> need. Why? Rates are low enough now to make a large reduction in
> the family housing allowance. But, the inability to refinance because
> of a lowered property value, or a lowered income because of family
> economic changes continues to trap people.
> Reducing the monthly payment will give more money to other types
> of spending. That should provide other people and businesses to sell
> and earn more profit. That will provide more working incomes that
> can purchase things, which provides more positive attitude changes,
> and ultimately, a revived economy.
> A key point is that refinancing is not losing money, it is paying
> off a higher rate loan, and borrowing at a lower rate. That is a
> sensible thing to do. The problem had been that the governments rules
> had prevented this from happening except in good times, and for only
> people that were doing well. This will help those not doing well
> to improve. Think of the credit card banks. They have someone bounce
> a check or miss a payment, what happens? They raise the rate to an
> amount that is worse than the corner bookie. B of A charges 28.99%
> in many instances. Is that wise? Not if you want to keep your customers.
> So who is getting paid off here?

Feb 19 05:28 PM

[Fabien Hug:]

Tedybearnail I fully share your frustration. This is an scandal.
Axelrod if we do what you propose, I am the first one to stop paying my mortgage.
Gvmt should choose its camp; creditor or debtor. The only way is to help the creditor; the bank. Let's foreclose and put these borrowers into 1 BR appartments (they can even take the chandelier) and close the gap at the bank level.
The bank will pay back the government and the depositors and creditors of the banks (pension funds, other banks) will not lose their money.

Feb 19 05:31 PM