Federal regulators announced a new plan yesterday to help households whose homes are worth less their mortgage refinance into new mortgages with lower monthly payment. The changes should be constructive because they will not only help the “underwater” homeowners that are at the heart of our nation’s housing problems, but also support the economy more broadly.
As in past economic slumps, the Federal Reserve has moved to combat the weakness in our economy through monetary policy. Reductions in the Fed funds rate, quantitative easing, and Operation Twist have served to reduce some interest rates to extremely low levels by historical standards. For example, news stories in recent weeks have focused on how the mortgage rate published by Freddie Mac has been hovering near 4 percent. But, those low interest rates do only limited good for the economy if many people cannot actually get loans at those rates, and that is pretty much what has been happening with mortgage refinancing. Lots of people who would have liked to refinance have not been able to do so because they are underwater with their loans, or they have blemishes on their credit records or irregularities in their income histories, or they do not have the cash around to pay for all of the costs associated with the transaction. In Fed-speak, we would say that the pipelines of monetary transmission are clogged.
All of the above factors are thought to have held back take-up of the first incarnation of HARP, the Home Affordable Refinance Program. The original HARP version, which followed on the Bush administration’s Home Affordable Modification Program (HAMP), was restricted to borrowers only moderately underwater. And within this group, many borrowers reportedly could not actually get rates as low as the Freddie rate because of fees tacked on to compensate for being less-than-perfect applicants. As a result, HARP has had decidedly mixed results, as noted in the Washington Post.
Banks have also been reluctant to make new mortgage loans because of the “put back” risk stemming from provisions in their contracts with Fannie and Freddie that allow the agencies to force them to buy back the loans if they do not perform as expected. With similar provisions in earlier contracts now coming back to bite lenders who overreached during the credit boom, banks have had reason to proceed with great caution on this front.
The revamping of HARP will reduce or remove these obstacles. In doing so, it will provide real relief to those mortgage borrowers who are able to make use of the program. Yet, economists are divided on how much support it will offer to the macroeconomy as a whole. One caveat is that the program is not a free lunch—refinancing borrowers gain from their savings, but lenders and investors see a reduced return of the same amount. Thus, for the program to have a net positive effect, borrowers need to have a higher propensity to spend than those who are funding the mortgage. On the whole, they probably do, notwithstanding the consumers who have gone into deleveraging mode since the crisis began. A second caveat is that the expected take-up of the revised program—800,000 to 1 million households—is small relative to our economy, amounting to just a fraction of the 10 million homes currently under water.
Still, with all of policy focus on keeping interest rates low, a program that allows more households to take advantage of these rates is a welcome step in the right direction.