By R. Tamara de Silva
October 25, 2011
On October 24, 2011 the Federal government announced that it would revise the Home Affordable Refinance Program ("HARP"). HARP was originally launched in March 2009 as a $75 billion plan to put a stop to the foreclosure crisis. HARP was supposed to prevent millions of the 9 million American homeowners facing foreclosure from defaulting on their mortgages and losing their homes. Yet as of this past July, HARP has only helped 865,000 of the 9 million homeowners who must refinance their home loans or soon default.
The housing crisis is by all accounts far from over. The bottom has yet to be reached in the housing market and one cannot but wonder how mortgage defaults would be affected were the Federal Reserve not to keep interest rates continually suppressed. Recently, Moody's announced that foreclosures will rise to unprecedented levels in 2012, enveloping 30% of all mortgages and totaling over 1.5 million defaults.
Yesterday, President Obama went to Nevada to sell his reincarnation of HARP. The specifics of the new HARP ("HARP2") are as follows:
• The mortgage must be owned or guaranteed by the government owned, Freddie Mac or Fannie Mae.
• The mortgage must have been sold to Fannie Mae or Freddie Mac on or before May 31, 2009.
• The mortgage cannot have been refinanced under HARP previously unless it is a Fannie Mae loan that was refinanced under HARP from March-May, 2009.
• The current loan-to-value (LTV) ratio must be greater than 80%-it is not capped, in other words, there is no loan to value restriction on qualification.
• HARP2 only allows alteration of the interest rate and term of the loan-it is not possible to take cash out by refinancing.
• The borrower must be current on the mortgage at the time of the refinance, with no late payment in the past six months and no more than one late payment in the past 12 months.
The Federal Housing Finance Agency estimates that 800,000 to 1 million homeowners could take advantage of HARP2-it is being far more modest in its estimations of HARP2.
In support of HARP2, the White House's own blog offers the following statement:
Nearly 11 million Americans are underwater on their mortgage, meaning they owe more to the bank than their homes are worth. In fact, homeowners have lost $7.25 trillion in home equity--the difference between the actual value of a home and the balance of what's owed on the mortgage--since the peak of the housing bubble in 2006. This loss in home equity is devastating for a family's financial security, and makes it more difficult to take out other loans, save for a bigger house, or build a nest egg for retirement. It also means families are making payments that are higher than they would be if their mortgage was based on the actual current value of their home, giving them fewer dollars to spend on other economy-bolstering goods and services.
The government began interfering with the housing market by aggressively advocating the idea that every American should own a home for the past twenty years-this advocacy, leaving aside its dubious philosophical underpinning has not gone entirely well. The federal government forced and incentivized loans to be written to lower income earners and particularly in what it deemed economically disadvantaged urban areas. The government played an active role in setting the table for the housing bubble by being so enamored of the idea that homeownership be perfectly democratic, that it dictated the writing of sub-prime mortgages, even as housing prices went straight down. This was not a one party campaign either because legislators on both sides of the political aisle enacted policies that encouraged home ownership at all costs even with low FICO scores, little or no money down, and little or no supporting documentation.
One argument against using HARP2 to prop up the housing market by preventing people that are headed to default from going through foreclosure is that housing is not an engine of economic growth per se. Housing does not grow the economy-it is the result of an already growing and prosperous economy. Housing is not a consumer durable nor is it an investment like gold or a retirement or savings account. The housing market drove the economy in terms of construction, furnishing and development, etc. However, consumer consumption in terms of the use of unrealized equity as its driver, drove the economy in an unsustainable manner. A significant proportion of all underwater mortgages likely resulted from home equity loans being taken to fuel purchases and the consumption of consumer goods, the homeowners could not otherwise have afforded to buy and should not have bought in the first instance. To the extent that this credit driven spending drove economy, it was always doomed to have a shelf-life.
In any functioning marketplace, the forces of supply and demand without interference will dictate price. Price is one of, if not in many instances the single most relevant information provided in any approximation of an efficient market. "What did you pay for that?" is more than vaguely related to "what is it worth?" While the price paid for a piece of art is not often a precise indicator of what it is worth, it is a good starting point. However, regardless of the price paid for a Monet or a November Soybean contract, the more important question soon becomes, "what is it worth?" If I owned a bushel of November 2008 soybeans, I could look at the spot or cash market and know immediately what the value is of what I own. A stock portfolio consisting of listed stocks has an immediately discoverable value because listed stocks are marked to market everyday as buyers and sellers determine through the trading market, what listed equities are worth at any given moment. The owner of a financial instrument unlike the owner of a Monet, has an after market to which he can go to instantly determine the value of the instrument and where he can sell it.
When the government props up the housing market by either artificially suppressing interest rates or putting more money into keeping bad loans from defaulting, the government is preventing price discovery. We will never know the effect of all the foreclosed homes coming to market because we are postponing their doing so. The housing bubble's bursting is being delayed in order to forestall the pain it will inevitably cause. Yes, many homeowners will be renters and banks will face massive write-offs. Had this been allowed to happen two years ago, we would have now seen what housing is actually worth because the market would have absorbed the foreclosed properties already.
In many instances, the savings from refinancing will not be appreciable enough to prevent the inevitable default-it may postpone it.
Also, according to many analysts, the average savings for a refinanced underwater mortgage will not be appreciable. A homeowner saving $800 in mortgage payments a year is unlikely to use their extra $66 a month to appreciably stimulate the economy or perhaps even appreciably improve their lives. It may all be too little too late.
By allowing for the re-financing of mortgages with LTVs of 80-1000% or more, we are arguably creating yet another housing bubble. Moreover, we are prolonging the end of a recession in some part felt by a sharp and consistent decline in consumer spending since February 2008.
We are also, rewarding irresponsible banks and borrowers while penalizing anyone who saves by keeping interest rates so low as to even allow for a HARP2. Someone will pay for HARP2-shareholders of banks or taxpayers or both. HARP2 will allow participating lenders to offload default risk onto the federal government and to the extent that they are allowed to do so, taxpayers will pay for HARP2 as part of the increasing Federal Deficit.
What the White House is selling to prospective voters in advance of an election, as a way to keep people in their homes, is really just a way to temporarily mask an untold number of mortgage defaults which will ultimately have to be absorbed by the market.
Markets that punish prudence, savings and its more productive participants by shifting through taxes and debt the economic consequences of the irrational and less productive, are not free markets. Ultimately, incentivizing bad choices by punishing goods ones will affect economic growth more significantly than allowing a bubble to burst.
Consider Henry Hazlett's Broken Window Fallacy as opposed to Paul Krugman's argument that the terror attack of 9/11 that took over 3,000 lives and destroyed the World Trade Center, could constitute an economic good. What Hazlett illustrates in the story of a baker's broken window that the glazer's gain of getting to fix the window is the loss of money by the baker who may have spent the money he has to spend on fixing the window, on a new suit-giving the economic gain to a tailor-the end result of which was no net economic gain. In the end, many economic events lead to no net gain. HARP2 is such a story.
The history of the financial markets is replete with the occurrence of bubbles from the tulip bubble, the South Sea bubble, the Stock Market bubble of the 1920s, the Internet bubble and the Japanese bubble-but to name a few. Ultimately when excess supply was absorbed by the market, the forces of supply and demand ensured that price returned to an equilibrium. The world did not end, recovery began. It is time that the government allow the housing bubble to burst instead of infusing it with helium so that the economy may at last recover.@
R. Tamara de Silva
October 25, 2011