By Don Miller
Associate Editor
Money Morning
Although the new Obama administration housing plan is expected to help about 9 million struggling American homeowners avoid foreclosure, there are also concerns the proposal could actually extend the country’s economic woes by prolonging the freefall in housing prices.
Critics also fear the plan won’t help tens of thousands of borrowers in the most-battered housing markets who won’t qualify because the values have fallen too far.
The housing plan unveiled by the Obama administration Wednesday is intended to help 9 million struggling homeowners avoid foreclosure. But there are serious doubts about whether it will help tens of thousands of borrowers in the most battered housing markets who won't qualify because their values have sunk too far.
There also are other aspects of the plan that critics contend may actually extend the credit crisis and keep the housing market from finding a natural floor from which to rebound.
Tumbling home prices are at the center of the global financial meltdown, making the success or failure of the administration's housing plan a major part of its effort to end the deepening economic recession.
Obama’s ambitious $275 billion plan to halt soaring foreclosures nationwide offers investors, banks and bill collectors financial incentives to keep Americans in their homes by modifying the terms of already distressed mortgages.
But even an administration background briefing that was conducted in anonymity in order to ensure frank discussion made it clear that the plan is far from a panacea, according to McClatchy Newspapers.
The program has two parts:
- The first part calls for a collaboration with lenders to induce them to change loan terms for as many as 4 million homeowners.
- The second part calls for as many as 5 million homeowners to be able to refinance their mortgages so that they have more-affordable fixed-rate loans.
Under the first part of the plan, a loan-serving company would modify a mortgage so that no more than 38% of a homeowner's monthly after-tax income is devoted to monthly mortgage payments. The government then would step in to share the cost of the mortgage so that no more than 31% of the borrower’s income was tied up in the payment.
To lower the payment, the servicer would first reduce the interest rate to as low as 2.0%. If that's not enough to hit the 31% threshold, they could extend the loan out as far as 40 years. If that's still not enough, the servicer would forebear loan principal at no interest.
Critics think that this mortgage subsidy disrupts the natural process of letting the market find the floor for home prices.
"Not only do these gimmicks prevent home prices from falling to the market-clearing levels that would give private lenders the confidence to loan, but the continued specter of subsequent government-mandated modification will keep lenders out of the game," said Peter Schiff, the president of investment strategist Euro Pacific Capital and a frequent contributor to Money Morning.
Others complain the plan also doesn’t require servicers to reduce mortgage principal.
“For underwater loans, if you don't write down the balance to be less than the value of the house, people still have an incentive to default," Richard Green, the director of the Lusk Center for Real Estate at the University of Southern California, told U.S. News & World Report.
The other pillar of the plan offers homeowners the chance to take advantage of today’s low interest rates by refinancing if their mortgages are held by Fannie Mae (FNM) or Freddie Mac (FRE).
However, the refinancing plan only helps borrowers who owe up to 105% of their home's current value. That makes it unlikely that severely "underwater" borrowers will be able to take advantage of the loan modifications, which are supported by $75 billion in federal funding.
Of the nearly 52 million U.S. homeowners with a mortgage, almost 14 million, or nearly 27%, owe more on their mortgage than their house is worth, according to Moody's Economy.com.
Hard-hit markets in California, Florida, Nevada and Arizona hold the most underwater households, but homeowners in struggling cities, like Detroit, and other rust-belt enclaves will also be left out. Even suburban houses in some of the healthier markets – such as Denver and Washington D.C. – have dropped substantially in value.
For a homeowner who borrowed $380,000 and now has a house worth $270,000, "I just don't know what you do with that," Jared Martin, a mortgage broker in Bethesda, Md., told The Associated Press.
Mortgage servicers also won't be able to modify mortgages if the terms of their contracts with the investors who own the pools of mortgages won't allow it. These pools of mortgages, called mortgage-backed securities, are the so-called “toxic assets” that are at the heart of the global banking meltdown
Meanwhile, to balance the financial carrots and incentives in the plan, the U.S. House of Representatives is expected to pass legislation giving bankruptcy judges a powerful new stick – the leeway to modify the terms of certain mortgages to keep banks from moving to foreclosure.
As reported previously by Money Morning, that law – known as “cram down” in bankruptcy parlance – could backfire and even cause the mortgage market to seize up, as investors stop buying mortgage-backed securities out of fear a judge could unilaterally change the terms of the deal the securities were created around.
News and Related Story Links:
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McClatchy Newspapers:
Obama offers bold housing plan to limit foreclosures - Associated Press:
- Housing plan aims to help 9M, but leaves out many
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U.S. News & World Report:
Obama's Loan Modification Plan: 7 Things You Need to Know -
Money Morning:
Bankruptcy Law Changes Part of Obama’s $275 Billion Housing Plan. -
University of Southern California Lusk Center for Real Estate:
Web Site.