The Homeowner Affordability and Stability Plan

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To some extent, all of our forecasts regarding the future of the housing market depend on what the government does. If the government wanted, it could borrow a few trillion dollars and save every troubled mortgage in the country. While this would be foolish from a policy perspective, it would make our estimate of future foreclosures look silly.

After a series of ineffective attempts to address the tidal wave of foreclosures under the Bush administration, the Obama administration on March 4, 2009, unveiled the final details of the Homeowner Affordability and Stability Plan (HASP).2 This $275 billion plan has three primary components:

  1. Loan refinancing. The 56 percent of the 55 million homeowners with mortgages that are owned or guaranteed by Fannie and Freddie can now refinance to current ultralow interest rates, even if they don 't have 20 percent equity in the home, the old test (as long as they are current on their mortgage payments, haven 't been more than 30 days delinquent on their mortgage in the previous 12 months, and can prove their ability to afford the new debt). Now, the loan-to-value (LTV) ratio can be as much as 105 percent and still qualify for refinancing by the government-sponsored enterprises (GSEs), which could help millions of homeowners save hundreds of dollars per month in interest—and probably help many hundreds of thousands avoid default and foreclosure.
  2. Fannie and Freddie. It increases the government's financial commitment to Fannie and Freddie from $100 billion each to $200 billion each—a necessary step given the GSEs' accelerating losses, and likely future losses from the looser loan refinancing terms (a 105 percent LTV loan is obviously much more risky than an 80 percent LTV loan).
  3. Loan modifications. HASP provides $75 billion to help certain homeowners whose debt-to-income (DTI) ratio exceeds 31 percent (meaning their housing payments exceed 31 percent of their pretax income), as long as the home is owner-occupied and the loan balance is under $729,750. Under this controversial part of HASP, if a homeowners DTI is, say, 45 percent, then the mortgage holder or servicer would have to lower the interest rate for five years to get the DTI down to 38 percent and then the government would match the cost dollar for dollar to lower the DTI to 31 percent. There are also various financial incentives to servicers, mortgage holders, and homeowners.

This plan is more comprehensive and thoughtful than previous ones, although the Obama administration 's claims that it "will offer assistance to as many as seven to nine million homeowners"—four to five million who might be able to refinance with the GSEs and three to four million who might avoid foreclosure by having their DTIs reduced—is mostly hyperbole, especially the latter.

While the requirements and financial incentives associated with HASP 's loan modification plan will surely lead to a better success rate than previous loan modification attempts, that may not be saying much given the dismal prior experience. Wells Fargo 's experience trying to modify loans and reduce the number of foreclosures is illustrative.3 Wells Fargo was unable to reach 20 percent of homeowners at all, 25 percent were not interested in discussing debt relief, and 13 percent were investors or were delinquent on second homes. Thus, the bank could begin a conversation with only 42 percent of homeowners. Of these, it was able to reach agreement with half of them—representing only about 20 percent of troubled mortgages—and most of these quickly redefaulted.

The hard reality is that millions of homeowners can't be saved and will lose their homes for a variety of reasons: they lost their jobs and can 't afford even the lower payments; they they're too far underwater; the loan balance is above $729,750; or they don 't live in the home. Thus, we estimate that HASP, if it 's very successful (and we think it will be), might help two to three million families avert foreclosure and another one to three million refinance into lower rates over the next few years. This is a step in the right direction, but given that Credit Suisse estimated prior to HASP that there would be eight million foreclosures from 2009 to 2012,4 it is likely HASP will reduce the number of foreclosures by only 25 to 35 percent. If we 're wrong and the plan is more widely adopted than we anticipate, that would be good news—but it would also probably mean that its cost would be far more than the projected $75 billion.

In addition while the Obama administration talks about helping only "responsible homeowners" (whatever that means) who have been victimized by "subprime and exotic loans with exploding terms and hidden fees," the reality is that HASP will inevitably help many homeowners who knowingly stretched (even to the point of lying about their income) to buy houses they really couldn 't afford because they thought they would be good investments. They were counting on home price appreciation and, when the reverse happened, they were in trouble. This plan will bail out many of these buyers and somewhat insulate them from their bad investment decisions. Given the societal cost of the foreclosure wave, however, we think bailing out a moderate number of homeowners is a reasonable price to pay—though we 're aware that others vehemently disagree with our assessment.

All in all, the Homeowner Affordability and Stability Plan is a step in the right direction, but it is likely there will be many improvements over time—and it will probably cost far more than $75 billion to make even a dent in slowing the foreclosure tsunami, given that roughly $30 billion worth of mortgages are defaulting every month!

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