A Concrete Plan to Stabilize Housing

 | Aug 31, 2011 | 4:30 PM EDT
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This is a follow-up to the column I wrote last week, "Light at the End of the Tunnel." In that column I outlined the recent indicators that the Obama administration and Federal Reserve are not only promoting economic stability but are taking tangible actions to create it.

In essence, the Obama administration and the federal public sector overall are suing for peace. The war between the public sector and private sector is over. The new approaches being implemented are essentially a domestic Marshall Plan directed at re-establishing the private U.S. economy.

In last week's column, I briefly mentioned that the administration is attempting to coordinate with Congress to create a system that would allow Fannie Mae and Freddie Mac to both refinance their existing portfolios of mortgage loans and buy newly refinanced loans from banks.

The government will have to take many factors into account in order to reduce defaults and foreclosures and stabilize housing. It will have to determine which borrowers will be allowed to participate, and take into account low credit scores, loans in default, negative equity and investment properties. However, even as Congress and the administration are working through these issues, you should be aware of how this structure is likely to operate.

First, there is nothing new about suspending typical underwriting guidelines when refinancing existing mortgages. There is also nothing untoward in doing so. FHA and VA loans have a "streamline refinance" option built into them that predates the current housing crisis.

A streamline refinance allows a mortgagor (borrower) to refinance into a new lower rate loan without going through the qualification process again. If, for example, a VA or FHA loan holder has a 30-year fixed rate at 6.875% that was originated a few years ago and the current rate on such loans is 5%, the borrower is afforded the option of refinancing to the 5% rate with little or no paperwork. That's why it is called a streamline.

The Obama administration, with this new legislation, plans to extend that provision to current loans held by Fannie Mae and Freddie Mac and to bank loans that do not qualify for a refinance under existing rules.

Second, this process does not and will not cost the U.S. taxpayer anything. On the contrary, it will stabilize the housing and mortgage-backed securities markets by reducing defaults and foreclosures. The end effect would be that the value of the loans currently held by Fannie and Freddie would increase, and the U.S. taxpayer would actually make money through this process.

Third, some of this may be done unilaterally by the executive branch, through the U.S. Treasury. And there are indications that this is already being done. The key to implementing such a process without legislation is to ensure that it does not result in an increase in costs borne by taxpayers through Fannie and Freddie.

However, Fannie and Freddie are experiencing a rapid prepayment of existing loans being refinanced through typical bank operations, because mortgage rates have declined to record lows. If Fannie and Freddie simply retired those securities, they would in essence be going into what is referred to as run-off mode.

If instead Fannie and Freddie issue new securities that do not cause their total level of debt to increase, and cause the default rate to decrease, thereby increasing the value of their portfolios, they may do so without congressional approval or specific allowance by their regulator, the Federal Housing Finance Agency.

I have received several communications from former clients of mine from when I was in the mortgage business, alerting me that their lender/servicer has informed them, without provocation, that their loans were fully approved for a refinance to a lower rate with minimal paperwork. One of these loans, already owned by Fannie Mae, is on an investment property and has been in default for 18 months. The mortgagor accepted the new loan and will start making payments at the new rate immediately.

Another loan, also on an investment property, is owned by a regional bank. The bank told the mortgagor they could refinance the loan, lowering the payment by $400 monthly, and at closing, the loan would be sold to Fannie Mae.  

Lastly, none of this requires or allows for principal reduction. It is simply lowering the rates on existing mortgages.

As this process accelerates, and I expect that it will, the chief private sector beneficiaries will be the money-centers and regional banks that hold portfolio mortgages now. The two largest are Wells Fargo (WFC) and Bank of America (BAC).

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