President Obama’s State of the Union Housing Proposal

The president’s State of the Union speech contained very little on housing policy. The main housing news was “a plan that gives every responsible homeowner the chance to save about $3,000 a year on their mortgage, by refinancing at historically low rates… A small fee on the largest financial institutions will ensure that it won’t add to the deficit, and will give banks that were rescued by taxpayers a chance to repay a deficit of trust.”

The administration has not released details of this proposal, so my comments are speculative. Since the president says the plan is for “responsible homeowners,” this presumably means that those who are delinquent on their mortgage payments are not eligible. (There are currently about 4.1 million delinquent loans, with approximately 1.8 million of these delinquent for 90 or more days.) This program is also not for borrowers who are current on their payments but have homes valued more than their homes are worth (“above water”), since such borrowers should be able to refinance without a new government program. And this program is not for those borrowers who are underwater and have a Federal Housing Authority (FHA) or Fannie Mae or Freddie Mac (F/F) backed loan, since they can refinance under the recently ramped-up Home Affordability Refinance Program (HARP) started by President Obama. Thus, this program will likely be targeted to underwater borrowers who are current on their mortgage payments and who have a mortgage that is not backed by the FHA or by F/F.

Private lenders are reluctant to offer a new mortgage to an underwater borrower, so presumably this plan would offer a government-backed loan, such as an FHA loan. This would require legislation, as FHA does not give loans to underwater borrowers, even if they are current on their existing mortgage. The tax on the “largest financial institutions” (which would also require legislation), would be used to fund the increased credit risk exposure to FHA.

Who wins and loses from such a proposal? Underwater borrowers who have made their mortgage payments would gain, as they would get an FHA loan at a lower rate than they are currently paying. Some financial institutions would gain, as they would be able to get underwater loans—which present a higher default risk—off their books. Other financial institutions would lose, depending on the size and distribution of the new tax. Taxpayers would be unaffected, assuming that the tax is set at the correct level to offset any increase in credit risk to the FHA.

It is important to note that reducing mortgage interest rates for underwater borrowers should only contribute mildly to foreclosure prevention. The key determinant of foreclosure is the cumulative loan-to-value ratio for the borrower, with a contributor factor being an inability to pay due to job loss. This program would not affect the loan-to-value ratio, as the amount of mortgage debt is unaffected by the refinancing. (This is why the administration’s previous plans to lower mortgage interest rates, through the Home Affordable Modification Program (HAMP), did not result in a substantial reduction in foreclosures.) The plan might have a mild stimulus affect, as it transfers money from investors (who see prepayments of their holdings of loans paying a high rate) and from financial institutions (due to the new tax) to underwater borrowers (who the president says will gain about $3,000 per year in lower mortgage payments).