Mass Refinancing Won't Solve the Housing Problem

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With the country's housing market still anemic and a backlog of pending foreclosures, the Administration is reportedly considering a plan to refinance millions of extant mortgages at today's historic low interest rates - an idea kicking around the Beltway for at least a couple of years.

Columbia University economists R. Glenn Hubbard and Chris Mayer first proposed this idea in the fall of 2008. They realized that house prices are (in part) inversely related to mortgage rates and stabilizing house prices was needed to stem the ongoing financial blood loss. The plan's final vision allows homeowners with a GSE mortgage to refinance to a new fixed rate of around 4 percent.

Yet it begs the question, at today's historically low rates, why haven't more people refinanced on their own? Many do not qualify under traditional standards because they are delinquent, they are in negative equity territory, or have had major credit impairment. This policy will require a continual bailout of Fannie Mae and Freddie Mac, and, in the end, this plan can't deal with the severe negative equity issues many homeowners now find themselves in. The hard-to-swallow reality is that foreclosures are the necessary and much needed mechanism for "right-sizing" the housing market - the market's way of clearing out the excessive investment and inappropriate mortgages that built up during the bubble.

Funding for new and refinancing mortgages won't come back until foreclosures can be processed, and this refinancing plan doesn't do anything to address that. Pending Attorneys General class action lawsuits against lenders, opacity on loan-level data at the GSEs, a broken set of conventions governing loan servicing, and ultimately nonexistent employment growth all need to be dealt with in order to reorient the housing market.

In terms of this plan of generating stimulus, our own calculations provide a generous upper bound of approximately $90 billion per year in additional disposable income (the authors of the proposal themselves estimate $74 - 85 billion) with an assumed 25 million households participating. This amounts to about $300 to each household per month on average, an increase of less than 0.85 percent in personal consumption expenditures (PCE).

But it would be overly optimistic to assume all that money would turn into spending in the economy. Recent data shows that people are more likely to pay down credit cards or increase savings with this money. Only a fraction of the $300 per month in savings on mortgages will actually turn into economic stimulus.

The second intended benefit is that it puts the brakes on price declines and reduces the rate of foreclosure.

Certainly for those of us who own a home which has fallen in value, and the portion of the economy tied to house prices, arresting the decline in value seems like a good idea. But house prices were highly inflated over several years leading up to the crisis. In some cities, prices are still above pre-crisis levels. By attempting to put a freeze on downward price adjustments, we may just be delaying the inevitable clearing of the market and a painful but necessary economy-wide adjustment of reducing debt.

Proponents argue that this plan is virtually free since taxpayers are already on the hook for massive losses on mortgages through our bailout of Fannie Mae and Freddie Mac (GSEs). We disagree, as this plan would increase losses at the GSEs, and much of these costs will be passed on to investors, including already troubled pension funds. Fannie and Freddie's conservator is explicitly tasked with minimizing taxpayer losses and this could be a direct violation of that mission.

Add to that the inevitable lawsuits by some investors for lost income and increases in future mortgage funding costs due to this unilateral rewriting of terms, and this plan starts to look less and less free. The dismal performance of previous mortgage modification programs gives us additional pause about the success of this plan. The idea was to keep people in their home and current on payments, but in reality, most borrowers ended up right back where they started - in default.

It would be nice if we could wave a magic wand and "put it all right," but this plan fails to recognize the true costs that taxpayers, and homeowners, would have to bear. Not to mention that banks would likely take another beating on their portfolios. Seems like a lot of work to end up back where we started.

 

Anthony B. Sanders is Distinguished Professor of Real Estate Finance in the School of Management at George Mason University.  Satya Thallam is the former Director of the Financial Markets Working Group at the Mercatus Center at George Mason University. 

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