A government streamlined refinancing program that would reduce monthly mortgage payments for a large number of borrowers appears more likely while insiders fret over its future cost burdens on borrowers, the government and investors.
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The most likely scenario, according to Keefe, Bruyette Woods analysts is an expansion of the Home Affordable Refinance Program “to make it more user-friendly” making it easier for borrowers to refinance. While a broader refinance program is unlikely given the meaningful costs to bondholders.
American Enterprise Institute resident fellow Ed Pinto told this publication he “generally agrees” that a targeted program designed to expand HARP “is definitely more likely” than a blanket program. It may take time to organize and implement since it will likely run into “some of the same headwinds experienced by HARP,” such as closing costs and fees, and the offset effect of securing some savings for the borrowers while investors lose income.
Apart from the long-term gain of creating the precedent of actively targeting existing borrowers for a refinance, he said, an expanded HARP “does not address the real problem, negative equity.” If some action is taken it needs to offset the reduction in monthly payment with increased principal amortization to deliver “and directly address the upside down loan problem.” In his view a better way to address the mortgage problem would be by focusing on creating more private sector jobs that in turn “will spur” housing demand.
A streamlined refi program however appears to make sense to the administration and the Fed who see Fannie Mae and Freddie Mac as vehicles that can boost the economy by making it easier for borrowers to refinance a mortgage loan, even though Fannie and Freddie guarantee over half of the country’s $11 trillion in mortgages, KBW analysts argue.
Their concern is that a blanket refi program could also mean a temporary freeze on the Fannie-Freddie mortgage portfolio size, or arrangement to keep their portfolio compositions unchanged by diverting reinvested proceeds “into MBS rather than treasuries,” which is not good news for investors.
It also means the likelihood the Fed will launch QE3–the third installment of its QE program that authorizes the Fed to buy distressed assets as a way to mediate the crisis, probably by the end of September–is much higher. “The first two QE programs were not that effective in bumping the economy up from its slow growth path,” analysts write, so “a third program, which should be incrementally weaker,” will not be any more effective.
It may be on its way however. In August, despite fears of a new recession, the risks it poses on the U.S. economy and housing market, the central bank unveiled a new policy tool and pledged to guarantee low rates until mid-2013.
In his annual speech at the Wyoming meeting with policymakers and academics last Friday Federal Reserve chairman Ben Bernanke reviewed the direct and indirect ways today’s weak housing market is affecting the overall economy. Housing activity may stabilize and grow again “over the medium term,” he said. “Good proactive housing policies could help speed that process.”
Previous KBW reports note that any proposal is likely to have a moderately negative impact on the Fannie Mae and Freddie Mac MBS REITs. The total estimated cost of a broad refinance program to bondholders would be roughly $300 billion if the average premium on the $4.4 trillion of Agency MBS outstanding is 7 points.
The argument in favor of a broad action is that it would be a way for the government to provide a benefit to borrowers with no direct cost to the Treasury, analysts wrote, with some of the costs would fall on the government and indirectly to future homebuyers. “The mortgage market would have to price in incremental risk to incorporate the political risk of bonds being called based on changes in government policy,” unless future GSE prospectuses include a promise that this would never happen again. The Home Affordable Refinance Program was created to benefit higher LTV borrowers but it has had only moderate success and benefits LTVs under 80% “who do not need it.”
These insiders say Federal Reserve Board Governor Elizabeth Duke has provided “a blueprint for what will eventually be the tweaks” in how an expansion of the government sponsored refinancing process may look. And it may involve mortgage-backed security financing support.
Despite her claim that suggestions made were her personal opinions, KBW analysts wrote, the timing of Duke’s “The Housing Market Going Forward: Lessons Learned From the Recent Crisis,” speech indicates her focus on the four main weaknesses of The Home Affordable Refinance Program provide a hint into the future.
Her speech followed Federal Reserve Chairman Ben Bernanke’s “Good, proactive housing policies could help speed” the housing recovery speech in Jackson Hole and preceded President Obama’s recent address about plans to boost the economy. Duke lists the top issues that have stalled HARP refis and should be improved including Loan Level Price Adjustments that lead to higher interest rates; lack of lender competition due to deferring of risk; allowing junior lien holders to avoid re-subordinating their positions; and the unwillingness of mortgage insurers to re-underwrite their policies.
What Duke failed to mention, analysts wrote, is the removal of the loan-to-value restriction that currently is capped at a 125LTV and most likely will be reconsidered.
In essence both the Fed and KBW analysts find an expansion of the HARP program would make sense only if it is revised to make it less restrictive despite its challenges. For example, stumbling blocks include “waiving reps and warranties,” which analysts find, may be “difficult to achieve,” compared to the other proposed changes that appear easy to implement. KBW believes the Fed will effectively support this program by beginning to reinvest the proceeds of maturing MBS back into MBS rather than into treasuries as they are currently doing.