Letting homeowners refinance at historically low rates would conjure billions of dollars of relief without the approval of a do-nothing Congress. What's the downside?
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Last week's $26 billion deal between the government and banks accused of mortgage fraud was the most significant effort to hold financial firms accountable for malpractice in the housing bust. The feds plan on using most of the money as a life-raft for homeowners who are underwater, or owing more on their mortgage than the value of the house.
But the deal is insufficient to address the housing crisis, and the U.S. economy still needs massive mortgage refinancing to flush out the worst of our debt overhang.
Since August, rumors have been flying around Washington that the White House was this close to putting out a plan to massively expand mortgage refinancing through its government-sponsored enterprises, such as Fannie Mae. This plan would let more homeowners refinance at historically low rates. Like waving a magic stimulus wand, it would conjure billions of dollars of relief for homeowners without Congress' approval.
WINNERS AND LOSERS
Last year, the administration updated the Home
Affordable Refinance Program, or HARP, to allow borrowers to take advantage of ultra-low interest rates by refinancing their Fannie and Freddie-backed mortgages. In the State of the Union, Obama laid out a plan that would allow underwater homeowners whose mortgages were not owned by Fannie Mae or Freddie Mac to refinance into loans backed by the Federal Housing Administration.
The White House plan looks unlikely to pass, as House Speaker John Boehner has strongly criticized it. But if the White House is able to pass its plan -- or convince the Federal Housing Finance Administration, which oversees Fannie and Freddie to massively expand its current refinancing programs -- it would be a huge boon for homeowners, at a loss for some investors. (The money has to come from somewhere, right?)
Any expansion of refinancing means a transfer of money away from investors so that homeowners' monthly mortgage payments go down and their ability to save or spend goes up. Refinancing leads to a loss split up between different types of mortgage investors, but the effect on investors' income is likely to diluted (I'll explain shortly), while the permanent reduction in mortgage payments for homeowners is like an immediate, permanent tax cut. Homeowners win, a lot. Investors lose, a little.
How would the plan stimulate? Simply, it would push dollars - hundreds of billions of dollars, potentially -- into the hands of people more likely to spend it. As Joe Gagnon, a former Fed economist, has pointed out, homeowners would likely spend more of their new income than investors would cut back due to their lost income.
DEALING WITH THE LOSSES
When a mortgage is bundled and securitized with other mortgages, the holder of that security benefits from the stream of mortgage payments. If that stream of money changes - e.g. if a homeowner refinances by taking out a new mortgage at the lower prevailing interest rate - the investor suffers.