The rumor mill is suggesting that Obama has an “August Surprise” in the works in the form of massive mortgage writedowns by Freddie and Fannie.
Rumors are running wild from Washington to Wall Street that the Obama administration is about to order government-controlled lenders Fannie Mae and Freddie Mac to forgive a portion of the mortgage debt of millions of Americans who owe more than what their homes are worth. An estimated 15 million U.S. mortgages – one in five – are underwater with negative equity of some $800 billion. Recall that on Christmas Eve 2009, the Treasury Department waived a $400 billion limit on financial assistance to Fannie and Freddie, pledging unlimited help. The actual vehicle for the bailout could be the Bush-era Home Affordable Refinance Program, or HARP, a sister program to Obama’s loan modification effort. HARP was just extended through June 30, 2011.
It’s almost a good idea…
The reality is that until we can figure out how to deal with the huge negative equity overhang (the fact that mortgages are higher than property values) our financial system is going to be looking very zombie-like – they are working hard to hide the losses, and while they have those unrecognized losses, they’re highly risk-averse and generally unwilling to add liquidity to the system by, like, lending. They’d rather borrow fed funds and buy federal securities and lock in profits…
On one extreme, there’s an argument that we just write it off (which is what’s proposed above), give the lenders their lumps, and clear the wreckage afterward.
The problem is that this is a massive transfer of wealth from the taxpayers to the underwater homeowners; there’s also an equities problem because other homeowners (me) have lost a bunch of equity in this collapse, and we won’t get our mortgages reduced…which is why I hope this is a nonstarter for Obama, because the political fallout would be toxic.
But it’s just a few feet away from being a good idea.
…we offered people the chance to refinance at a low rate and knock 20% off the value of their mortgages, but asked them to give up their mortgage tax break and to give the lender a slice of any future increase in value?
We are massively overinvested in housing and have been for some time (note that we’re not alone, it’s a worldwide phenomenon – I should do a post on this). We see that in 1,800 sf starter homes, 4,500 sf 4br McMansions, a plethora of granite countertops and other trim that were once the province of luxury homes and now are – normal.
We’re going to downsize our housing over the next generation – smaller, cheaper, more efficient (not necessarily more urban).
How do we do that? how do we move housing from being valued as an investment (which brings consumption benefits) to being valued as consumption (which may bring investment benefits)?? the Canadians, as an example, maintain tight lending standards and don’t have a mortgage interest deduction.
We shouldn’t either.
But that transition is going to be messy and painful. So let’s bribe people to make it…
…and let’s start with the people in trouble – many of whom (like one of my neighbors) just happened to buy in the wrong place at the wrong time with too little equity – but are people who add to the community, stable, etc. etc.
So here’s a deal:
We’ll replace their current mortgage(s) up to some value $X with one at 80% of their total value at, say, 4.75% for 30 years, prepayable at any time. But you can’t deduct the interest on this mortgage.
In addition, we’ll have a second note that has a face value of one dollar, plus 33% of the profit you make in selling the home for the next fifteen years. If you don’t sell, you can pay it off for a buck.
We’ll securitize the loans, and the ‘kicker’ will have some value – Wall Street will work it out – but the value will be more than zero, which is what taxpayers would get under the plan suggested above.
It’s not perfect – there are still lots of issues, and we’re really trading losses now for revenue (higher income taxes by the beneficiaries) plus some possible future value.
But isn’t that better than trading it for nothing at all??