Jose D. Roncal
There have been so many bail-out packages, stimulus proposals and other unprecedented plans designed to save the economy, it’s become nearly impossible for the casual observer to keep track of it all. Next up: sorting out the mortgage problems and finding a way to stem foreclosures with the aptly named Housing Recovery Plan. We’re not sure if the purpose of all this is to stimulate an economic recovery, or stabilize the recession.
If the purpose of the housing recovery plan is to stem the tide of foreclosures and keep millions of borrowers in homes that they can’t afford, we see some moral hazards ahead.
It’s one thing to say that this program “will not reward folks who bought homes they knew from the beginning they would never be able to afford,” it’s quite another to identify who those particular folks are. We’ve all heard that property values are in such sharp decline, that many homes are worth less than the mortgage balance, and that people are just walking away. But how do you identify the people that truly can’t afford to make their payments versus those who simply refuse to?
We’re talking about up to nine million individual cases here. Considering that mortgage fraud was rampant during the housing boom, it’s a safe bet that there will be plenty of unscrupulous citizens lining up with their hands out.
The plan will undoubtedly soften the blow for many homeowners, but by investing in failure, will it also prolong the housing downturn and make financing a home purchase further out of reach for qualified borrowers in the future? Might this simply perpetuate the circumstances that got us into this mess in the first place and prolong the pain of recovery for everybody else? We predict that nothing in the Housing Recovery Plan will actually have an effect on the continuing decline in housing prices.
If the plan does get off the ground, we’ll be giving our tax dollars to lenders in the hopes they will be enticed to modify their loans and help borrowers refinance. That might include lowering monthly payments or reducing the face value of the mortgage. So far we haven’t seen much payback from investing hope and tax dollars into the banking system.
Fannie Mae and Freddie Mac are going to be encouraged to buy more mortgages in order to keep rates down, but they are already so stretched, the last thing they need is to take on more risk. There is a delicate balance to reach. In an already flailing banking system, if banks are forced to reduce the mortgage principal, it would reduce the value of mortgage securities held by all of them: pension funds, the Federal Reserve, Fannie Mae and Freddie Mac.
What if we infuse another sizable chunk of money in to the system only to discover that it’s still not enough? Even though lenders were to reduce mortgage terms, if housing prices keep falling, borrowers could be faced with the same problems down the road, even after lenders have already taken a hit.
A lot of objections are being raised about the basic fairness of this plan. Should homeowners who were prudent and responsible be expected to subsidize the millions who weren’t? And what about separating the honest homeowners from the sharks? What’s the incentive for doing the right thing, or the disincentive for doing wrong?
Economist Nouriel Roubini believes the plan relies too much on accepting that the banks will voluntarily reduce mortgage payments with the government chipping in to make up part of the shortfall. Federal Reserve Chairman Bernanke agrees that we need face value debt reduction of mortgages, but unless there is a significant reduction on the face value of the mortgage, most people still won’t be able to afford their payments.
We agree that this is a serious situation that needs a solution. But if we don’t take time to work out the problem of fairness to the taxpayer or find a way to prevent fraud, we might just be rushing headlong into another black hole. So far none of the recent plans to get the economy back on track have much effect—other than to drive the Dow further into a ditch.
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