Tackling the Mortgage Mess

Yesterday, President Obama unveiled a $280 billion plan to address the mortgage crisis.  As we at NDN have long argued, the financial and now economic crisis began with mortgages and addressing the foreclosure crisis is critical to resolving them.  The package unveiled yesterday was large and bold.  Here are my thoughts.

The plan follows the three pronged structure I proposed earlier this year of first, developing a simple, national modification plan, second, permitting judges to modify mortgages in bankruptcy court and third, allowing people to refinance out of unsustainable higher interest mortgages into sustainable ones.  of these I argued that the third piece was the most important. 

With respect to modification, the Administration has essentially taken key terms of the loan modification in a box program of FDIC, extended it and offered a new carrot to banks in the form of direct subsidies if they modify mortgages.  $75 billion is allocated to lower monthly payments to a percentage of income.  This modification program remains, however, voluntary.

The plan has also endorsed allowing judges to modify mortgages in bankruptcy court.  As a practical matter, a key effect of this would be to give borrowers more leverage in bankruptcy court and therefore encourage lenders to make a deal.  This proposal will, however, require legislation. 

Finally, we come to the issue of allowing people to refinance out of problem mortgages into sustainable ones.  The President's proposal dramatically increases to $200 billion the funds available to buy FHA mortgage securities in the secondary market and hence encourage refinancing and purchase of homes by lowering rates.  This is certainly a good thing.   In turn, it will allow holders of "conforming" FHA mortgages--those under 417,000 or 730,000 in some high cost areas to refinance more than 80% of their home value, ending the need for Private Mortgage Insurance or the PMI that adds to one's monthly payment.  It will be easy for the government to effect this change as it now controls Fannie Mae.  Indeed, an advantage to both proposals in terms of acting quickly is that they require no action by Congress.

The proposal yesterday stopped short, however, of endorsing a 4% government guaranteed mortgage as I advocated that would have let far more people refinance out of problem loans into sustainable ones.  Instead, by using the existing Fannie Freddie format, it will allow some people to refinance at the normal Fannie rate which now runs at about 5-6%, but only people that already hold FHA mortgages.

Here are my thoughts.  The plan is a solid one that can be put into place relatively quickly.  It will keep many people in their homes.  It will not, however, lead to the wholesale retirement of the unsustainable exotic and often deceptive high rate mortgages--and securities and derivatives based on those mortgages--that continue to riddle the mortgage system.  As loans taken out in 2006 and 2007 reset in the next few years, these exotic loans will create further systemic stress.

Apart from my continued support for a 4% mortgage to completely retire and clean up this unsustainable chapter in American home lending, I would recommend one tweak to the proposal.  As it continues to flesh out details, the Administration should extend the same terms it is extending to FHA loan holders to anyone holding a non FHA mortgage in order to retire as many problem mortgages as possible.

In coming months, we will see if the voluntary plan and subsidies being provided to banks are adequate to see large scale modification.  If not--and if the Administration decides it wants to work with Congress to legislate in this area, the 4% US guaranteed mortgage remains the best way I can envision to retire unsustainable mortgages, clean up the balance sheets of banks, lower family payments and free up demand in the economy.