There’s a lot of new interest in tackling the housing sector, starting with a big paper out of the Federal Reserve, The U.S. Housing Market: Current Conditions and Policy Considerations. Ezra Klein has a piece this morning on Glen Hubbard arguing that mass refinancing and housing is one of the few ways President Obama can fix the economy without Congress.
It’s great to see the Federal Reserve finally getting to the table on problems in housing. Fixes to housing would be complimented by the Federal Reserve following Joe Gagnon’s advice: “In addition, to boost the overall economy and to maximize the benefits of mortgage refinance, the Federal Reserve should announce new large-scale purchases of agency guaranteed mortgage backed securities (MBS) with the goal of keeping the 30-year mortgage rate between 3 and 3.5 percent through the end of 2012. These purchases would have beneficial spillovers into almost all other financial markets.”
There’s been a bunch of discussion on this topic, but one thing I haven’t seen mentioned is the distributional consequences that result from underwater homeowners not being able to refinance. From the CBO’s recent An Evaluation of Large-Scale Mortgage Refinancing Programs (my bold):
A measure of the difficulty borrowers are experiencing in refinancing their mortgages is the unusually high premium over the face (or par) value that investors are willing to pay for MBSs with high coupon rates. The availability of the option to prepay the mortgage usually prevents the price of MBSs from rising too much above par value. In general, a coupon-paying bond, including a mortgage-backed security, will increase in value when interest rates fall. For MBSs, however, large increases above par value are uncommon because the decline in interest rates tends to speed up the rate of prepayment on the underlying mortgages and, hence, MBS investors do not expect to receive an above-market coupon for very long. The current high pricing suggests that investors expect impediments to refinancing to prevail considerably longer than usual. Chart 5, based on Fannie Mae 30-year MBSs that have coupons that are approximately 1.5 percent above the prevailing par coupon rate, shows that investors have increased the price for those securities since 2009. Although many factors affect pricing for MBSs, a strong case can be made for lower prepayment expectations as an important component in the price premium investors are currently willing to pay for those securities.
There’s a zero-lower bound on interest rates. Even though interest rates remain very low, they are still too high relative to where the economy needs to go. But low rates allow homeowners to refinance into lower rates on their debt, healing their balance sheets and boosting overall demand. This is true for most except for those who are underwater in their mortgages – they can’t refinance, and the government programs that have tried to help (HARP, notably) have failed.
Fixing this would help with the unemployment crisis – areas with the most people underwater have the highest unemployment and could use the extra spending cash (and lower debt servicing burdens):
But look at the CBO argument – a valuable investment for rentiers to have in weak economic times are people whose debt burdens are significantly above prevailing interest rates, which is exactly what we find with underwater mortgages. There’s a significant premium for these types of debts, and it isn’t shocking that a lot of resources have been put into motion to protect this premium. Beyond being part of what is holding back the economy, a lack of refinancing is a significant boom for creditors.