Regarding option #1, Morgan Stanley says:
Modifications and refis. Loan modification or refinancing programs like HAMP can be helpful, but have not put housing finance on track for sustainable improvement. Unfortunately, they do not address the fundamental supply-demand imbalances in housing, and they are not widely available. Beyond the factors restricting the supply of credit noted above, second liens complicate modification programs because they must meet certain criteria to be eligible for modification, which limits the number of mortgages that can be modified.I must say I think mortgage refinancing is one of the stupidest ideas in the world. Do you really think the problem is too high interest rates? If we lower the interest rate by 1.5-2%, are people going to be magically able to afford their homes? I think not. The problem is that people cannot afford their mortgages. However, this would be a politically popular idea because it extends the housing crisis for a few more years. You give everyone a new 4.5% mortgage, and within a year, 60% of mortgages are back in default. Perhaps Zimbabwe Ben could lower mortgages rates to 2.5%, and we can refi some more mortgages to help keep people in their homes. This bogus solution sounds like a winner to the incompetent pieces of filth in Washington. I have said this before, but I will say it again: People who cannot afford their home should be promptly foreclosed upon. Their should not be any government interference. It is a torturous process to follow, but it will ultimately lead to stabilization in the housing market, which is in every one's interest. Let's take a look at Morgan Stanley's next solution to the housing depression:
‘Streamlined' refinancing programs are one answer. The federal government could open the refi process to existing borrowers who cannot now qualify for a lower rate by recognizing the guarantee that already exists on the principal value of a very large portion of the mortgage market - specifically, the mortgages that are backed by Fannie, Freddie and Ginnie. Of the 55 million households with mortgages, 37 million have mortgages whose principal value is guaranteed by the federal government. Given the credit restraints noted above, we believe that perhaps 50% of the outstanding principal value of agency mortgages may not be refinanceable at present. If the GSEs were to allow those 18 million borrowers to refinance at 4.5%, it could reduce aggregate interest payments by up to $46 billion annually. Such a policy would apply only to refis, not new mortgages. It would not entail any new cost to the government, and the lower payment burden likely would reduce future defaults and thus credit risk for the guarantor of the mortgage (i.e., the US government).
Option #2: Write-down principal. As the discussion above implies, write-downs or forgiveness of principal are the real solution to housing woes. Policy options to reduce principal take two forms: those encouraging principal write-downs to avoid default, including so-called strategic defaults, and those encouraging short sales, which allow underwater borrowers to sell their house at market value without writing a check to the current lender. Such programs exist, and some lenders have offered them to borrowers in lieu of foreclosure, but restricted eligibility has limited their success.I actually like the idea of principal write-down for underwater homeowners. It would have to be rather substantial write downs like 30-50% in some cases, but it would make the mortgage more affordable for the homeowner. My only problem with this idea is that I do not like the idea of the government mandating principal write-downs. It is illegal for government to tell the banks to this. As long as the banks voluntarily do it, I have no problem. It is a free market solution by private parties. The only catch is that the banks do not own the majority of mortgages in this country. Most mortgages have been packaged into MBS so you would have to get the owners of these MBS to agree to any principal write-down, which would be challenging. The servicers could not unilaterally make this agreement on behalf of the MBS investors. However, it is probably in the interests of the MBS owners to take a write-down instead of having to foreclose and sell the house in a depressed market.
Adding incentives for both borrower and lender could make such programs much more attractive. The best approach gives incentives to both. For example, in March, the Treasury proposed the idea of ‘earned principal forgiveness', where FHA refinancing would be available to underwater but performing borrowers if the lender agrees initially to forbear principal and thus modify payments, and to forgive a portion of the forborne principal at the end of each year the borrower is current on the modified payments. Such a plan gives the borrower both payment relief and an incentive to stay current, with an option on future home equity, and it gives the lender a performing asset - one with a lower coupon but also with a lower probability of default. In August, HUD provided details on the FHA program, which was to start on September 7. We estimated that 300-600,000 borrowers within the non-agency securitized universe would likely participate in such a program. In contrast with the FHA program, HAMP 2.0 has focused on principal forgiveness for already-delinquent borrowers.
The jury is still out on both the FHA program and HAMP 2.0; each has been operational for only about three months. But two hurdles currently stymie broader participation in the FHA program: dealing with second liens and adding servicer incentives. Currently, there are no servicer incentives for the FHA program, and short refinancing will deprive servicers of fee income on performing loans. Without servicer incentives ($2,000-3,000 per loan would probably suffice), this program is unlikely to take off.
Streamlining short-sale programs would also help the write-down process for those borrowers who would otherwise go through foreclosure. Specifically, an expansion of the Home Affordable Foreclosure Alternatives Program (HAFA) beyond its current limitations could help to clear the market of such liquidations with minimal damage. To be eligible for HAFA, borrowers must have a verifiable financial hardship and either fail to qualify for a modification or else redefault. Servicers must consider every HAMP-eligible borrower for HAFA before the homeowner's loan is referred to foreclosure. But the process is slow, and some triage of the borrower pool could expedite the process for those cases with little chance of successful modification.
From a moral perspective, I despise idea of a principal write down for irresponsible people who took out mortgages they could not afford. I do not like the idea of rewarding these people for their foolish gamble to flip a house at higher price. Furthermore, it is a general F-You message to all of those honest, hardworking, responsible homeowners who pay their mortgages on time. These people get to play the sucker as they did the right thing but don't get any rewards. But then again, these people are used to playing the sucker as taxpayers for bank bailouts. This seems to be way the cookies crumble.
If you want a real solution to the housing depression, we have to have lower prices plain and simple. Morgan Stanley talks about a demand-supply mismatch, but this is not the truth. The problem is that home prices are still overpriced, and until prices fall, demand will not return. The solution is to allow the market to fall another 10-25% or until the market reaches an equilibrium. Unfortunately, this solution is not politically popular. But it is what needs to happen before we will ever see a bottom in the housing market. The market will work, despite government and Fed intervention; the only question is how long they can delay the process.
Black Swan Insights
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Housing will remaina mess for a while longer.
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