Who Will Prop Up Housing Next?

For weeks, the question has lingered: Now that the Fed is following through on its promise to stop buying up shaky mortgage-backed securities, what will the powers that be do to prop up the housing market next?

This morning, we have our answer, direct from the White House. And rest assured, you’re on the hook for some of it. The details in a moment… First, let’s step back and take stock of the government’s efforts to date.

A report just out from the Office of the Comptroller of the Currency delivers this startling statistic: 51.5% of delinquent borrowers who’ve gotten loan modifications defaulted again after nine months. Ouch.

Another new report, this one from the inspector general of the TARP program, confirms what we’ve previously documented: The Home Affordable Modification Program (HAMP) is a joke.

“A year into the program, although more than a million trial modifications have been initiated, the number of permanent modifications thus far, 168,708, has been, even according to Treasury, ‘disappointing,’” says the report. “The program will not be a long-term success if large amounts of borrowers simply re-default and end up facing foreclosure anyway.”

A big reason? Most of the modification agreements don’t reduce the borrower’s principal. In fact, in many cases, the principal grows. (Nifty way to shore up a bank’s balance sheet, eh?) The report notes that “HAMP allows principal reduction, but it is not typically implemented in practice,” and until it is, the incidence of “strategic default” will likely grow.

So into this breach steps the White House with its latest and greatest plan: Having failed to help underwater homeowners who are delinquent, it now proposes to help underwater homeowners who are still current with their payments. The highlights…

  • Borrowers who’ve lost their jobs can make sharply reduced payments — or in some cases, no payments at all — for up to six months
  • Banks will now be given an incentive to reduce principal… courtesy of you, the taxpayer: The government will use $14 billion of TARP money to cover their losses. A chunk of this money will be used to help clear home equity loans and HELOCs. In a foreclosure, those are second in line behind the primary lien holder, and, on an underwater home, are frequently worthless
  • Borrowers taking advantage of the program would refinance into a loan backed by the Federal Housing Administration. So the banks might book a loss (covered at least in part by the TARP money), but they’ll shuffle the risk of foreclosure onto the FHA — which faces rising losses on the loans it backs already.

All of this should work out for homeowners and taxpayers at least as well as HAMP, if not better. But if it cushions the fall in housing prices, well… mission accomplished.

Except for one fly in the ointment: If mortgage rates start to rise, all bets are off.

Dave Gonigam
for The Daily Reckoning