December 28, 2012 by 2 Comments

A few days ago, we discussed a proposed plan that would allow underwater borrowers with privately-held mortgages to  refinance into a government-backed (Fannie Mae or Freddie Mac) mortgage.  While the Home Affordable Refinance Program allows underwater borrowers with government backed mortgages to refinance, those with privately held mortgages have been left out in the cold and are often stuck paying above market rates.  Not surprisingly, this idea is facing some pushback from investors.

From CNBC:

“But the American Securitization Forum, which represents investors in residential mortgage backed securities, is balking at the idea, arguing that while underwater borrowers are at greater risk for default it’s not clear reducing their monthly payment will change that. It figures $120 billion worth of loan principal would qualify. Taxpayers would kick in $11.5 billion to make up for the reduced interest payments for the first five years and investors would subsequently lose $9.7 billion for the following years.

“The key question from the policy side for both investors and taxpayers is would providing this reduction in monthly interest payments provide any benefit either to the investors or to the public at large by reducing foreclosures? Our answer is we don’t think it will appreciably reduce people walking away from their homes,” said Tom Deutsch, executive director of ASF.

Investors have been unwilling to reduce interest amounts without reducing the risk of default. “If they are getting a 6 percent interest now, why would they want to turn that into a 3.5 percent if the borrower would still pay the 6%. It would seem wholly irrational to reduce their interest rate if it’s not likely to prevent a walk-away borroweror a foreclosure,” said Deutsch.”

While I don’t normally find myself in agreement with the ASF, everything stated here makes sense.  The re-default rate on loans modified through programs like HAMP have been very high, and it isn’t clear that the modifications were very helpful.  HARP would probably be a better analog for the proposed program, but I can’t seem to find much of HARP re-default rates – perhaps someone can help me out here.  One would assume that the re-default rate on HARP would be lower than on HAMP, because the HARP borrowers were current on their mortgages while many or most HAMP borrowers were delinquent.

The larger point is that this isn’t a good deal for investors in private residential mortgage backed securities.  The borrower who has a mortgage with an above market rate who cannot refinance and continues to make payments is a dream for investors.  There is no incentive from the investor perspective to refinance the loan unless doing so prevents default.  None whatsoever.

Of course, this really isn’t fair to the mortgage holder, who didn’t get the opportunity to determine whether or not their mortgage ended up in an MBS that was issued by the GSEs or privately, but that’s sort of the way the cookie crumbles.  Frankly, if the government is going to go through with this plan, I think they need to make the investors whole and pay for all the lost interest payments.

Whether or not it makes sense for the government to back even more high-LTV loans at record low interest rates is a question for another blog.  At this point we almost might as well go ahead and nationalize the whole mortgage market.  We’re pretty much there anyway.

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  •' Bill says:

    If the note says that the loan can be paid off, then they have to take a refi – from the government, or from whoever. Legally, the government doesn’t have to do jack.

    Also, The interest profits would have never been calculated into the cost of the loan at inception. When a homeowner took out a 30-year 6% loan in 2007, the originator had no belief that it be carried for a decade or more at that rate. Most refi within the first 5 years. It is built into the expectation of the loan. They have already had a gift for this going on as long as it has.

  •' Bill says:

    From my reading, the pushback referenced above isn’t against refinancing, but through loan modifications.

    There are two Obama plans. The first one doesn’t require congress, and would reclassify hardship as “underwater”, allowing homeowners to expand the use of HAMP to modify the interest rate. That’s the one which is facing resistance.

    The 2nd idea is to expand HARP by allowing Fannie/Freddie to charge slightly higher interest rates to account for the risk of the underwater loans. This requires congress. Nothing the investors can do about this one, as the loan will get paid off in full as a standard refi.

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