A New Program To Attack Underwater Mortgages

The Obama administration is, if nothing else, persistent in its efforts to turn around the housing market. The WSJ has the details on the next tilt at windmills which they will roll out on Tuesday:

The Obama administration on Tuesday will launch its most ambitious effort at reducing mortgage balances for homeowners who owe more than their homes are worth.

Officials say between 500,000 and 1.5 million so-called underwater loans could be modified through the program, the first initiative to target homeowners who are current on their mortgage payments but are at risk of default because they have no equity in their homes. Some experts are warning, however, that the same knots that tied up prior initiatives could do so again.

Under the new “short refinance” program, banks and other creditors that write down mortgages to less than the value of the property can essentially hand off the reduced loan to the government. The process involves refinancing borrowers into loans backed by the Federal Housing Administration.

According to the article, this program has been around since last March but apparently was never activated. Frankly, I don’t remember it but then again, I lost track some time ago of all of their initiatives. It’s a maze and I just react when they roll out their next dose of magic elixir.

Given that the program requires the mortgage holder to write down the debt to less than the market price of the home, it’s questionable how many will bite, particularly given that the loans have to be performing. The article properly points out that this will be a big problem for securitized mortgages as the legal documentation underlying them generally prohibits reducing the mortgage balance absent an imminent threat of default. They do suggest that it might appeal to institutions and investors that have already modified loans.

Analysts say that the program is most likely to succeed on loans that banks already own in their portfolios. It could also provide investors with a vehicle for getting rid of loans that have been modified and are current again. “It’s going to be a ‘take out’ for modified loans,” said Laurie Goodman, a senior managing director at mortgage-bond trader Amherst Securities Group LP in New York.

If indeed it’s simply a way for banks to unload previously modified loans what’s the point. I guess I can see the rationale for taking on this risk if it induces the mortgage holder to write down value and thus take out the default potential that accompanies negative equity but taking on mortgages that were already modified doesn’t seem to accomplish much aside from relieving the banks of potential loss at the expense of the taxpayer.

So what’s behind this. Well, the article contains one rather interesting observation:

The administration’s plan doesn’t target loans held by Fannie Mae and Freddie Mac, which own or guarantee half of the $10 trillion in U.S. first-mortgage debt, to avoid inflicting big upfront losses.

Instead, officials hope to reach more loans that were bundled by Wall Street firms and sold to investors as mortgage-backed securities. For more than a year, many of those investors, which include hedge funds and pension funds, have been clamoring for such a program because they have already had to mark down the value of their holdings.

“It’ll take some really crappy loans out of the marketplace…and replace them with much higher-quality” mortgages, said Scott Simon, a managing director at Pacific Management Investment Co.

So who are these hedge and pension funds that are clamoring for relief. Could it be bottom fishers who bought this stuff at deep discounts and have the flexibility to modify loans without incurring a loss. Is this just a means for them to cash out rather than holding onto these loans? Has the game been to not modify even though their acquisition price allows for it in order to induce the government to provide a liquidity facility?

I’m speculating obviously, but this program seems so pointless on its face that I’m induced to believe that there is something else at work. Just getting jaded I guess.

About Tom Lindmark 401 Articles

I’m not sure that credentials mean much when it comes to writing about things but people seem to want to see them, so briefly here are mine. I have an undergraduate degree in economics from an undistinguished Midwestern university and masters in international business from an equally undistinguished Southwestern University. I spent a number of years working for large banks lending to lots of different industries. For the past few years, I’ve been engaged in real estate finance – primarily for commercial projects. Like a lot of other finance guys, I’m looking for a job at this point in time.

Given all of that, I suggest that you take what I write with the appropriate grain of salt. I try and figure out what’s behind the news but suspect that I’m often delusional. Nevertheless, I keep throwing things out there and occasionally it sticks. I do read the comments that readers leave and to the extent I can reply to them. I also reply to all emails so feel free to contact me if you want to discuss something at more length. Oh, I also have a very thick skin, so if you disagree feel free to say so.

Enjoy what I write and let me know when I’m off base – I probably won’t agree with you but don’t be shy.

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