It is a very hot August and the heat seems to be getting to people on Wall Street. In Washington the greater heat stems from fears about the impact of the economy and housing on the mid-term elections. As a result, Wall Street is expecting a big “surprise” in the form of a massive GSE refinancing plan, an unbridled expansion of the unsuccessful HARP program.

Don’t hold your breath.

Ongoing rumors of a streamlined GSE induced refi wave began last week with notes from Morgan Stanley and Bank of America. Folks at these firms proposed that borrowers could benefit, resulting in increased consumer spending, if only the GSE’s initiated a streamlined and broad program to allow those of their mortgagees who are current on their mortgages to instantly refinance from their higher rate mortgages to current market rates.

The argument is, since the GSEs own the credit risk anyway, they should change the refinancing requirements and lower or eliminate appraisal requirements and LTV requirements for refinancing. Doing so would, it is suggested, lower the burden on borrower cash flows, as they would benefit by lowering their rates by about 150bp. The pitch was ‘it would be a costless plan with real benefits’. Nice theory, too bad it doesn’t work and isn’t possible.

Beside the small consumer stimulus there could be another argued benefit to such a plan. By increasing the ability of borrowers to pay their primary mortgage, the plan would appear to help Treasury’s ongoing process of creating disparate benefits to second lien holders.

There are several and significant problems with this plan:

- As a result of another prepayment-shock and the inability to model future prepayment shocks, investors would become even more unwilling to invest in MBS gong forward, or would begin to demand higher yields going forward; unwilling to invest in MBS going forward, or would begin to demand higher yields going forward;

- The interest rate risk that this would cause, as banks and the GSEs themselves all had to re-hedge their books at the same time, could precipitate a systemic risk issue;

- The prepayments would cost investors more than half a trillion in lost interest income;

- Such a “streamlined” refi program would cost state and municipalities billions of dollars in transfer fees that they would normally be able to charge on a refinancing;

- Keeping borrowers in their homes with rate reductions could be argued to be consistent with maximizing value under conservatorship. A streamlined and across the board refi program that treats all borrower LTVs and other features the same would appear to violate the conservatorship;

- The GSEs, according to their trust agreements, are prohibited from soliciting prepayments. If they were in receivership these agreements could be abrogated but they would still have to pay value on the contracts; and

- Servicer’s could solicit borrowers to prepay on the program but it would be a nightmare to operationalize and oversee such a massive program.

We have heard absolutely no serious discussion of this hare-brained idea in regulator or policy circles. While we do not expect the GSE rumor to prove correct that doesn’t mean the situation is static.

We will soon see the implementation of their previously announced HAMP and FHA short-refinancing programs. Even though initial HAMP results will not be reported until you can expect the Administration to “sell it hard” and play it up. The Principal Reduction Alternative in the “new” HAMP is voluntary1 but does state “participating 2MP servicers must forgive an amount of principal on 2nd liens in equal proportion to the amount forgiven on the first lien loan by the 1st lien servicer.”2 The fact that about half of all second liens and HELOCS are owned by the same banks that service the firsts on behalf of mortgage investors, and that those banks continue to hold the value of their seconds at prices that far exceed a fair mark, you can expect that this voluntary approach will be generally left unused.

Also, as early discussions on the FHA short-refi program were happening, there were questions of whether the GSEs would be involved. At the time we were hearing the GSEs were developing their own short-refinancing program. It remains unclear am what that would be but it is important to remember that the Federal Housing Finance Agency is acting as “conservator” to the GSEs. “The FHFA, as Conservator, may take all actions necessary and appropriate to (1) put the Company in a sound and solvent condition and (2) carry on the Company’s business and preserve and conserve the assets and property of the Company.” This suggests any short refi program would have to be narrow, as drawing it too broadly would cause the dissipation of assets from the conservatorship.

Those who would suggest this view of the conservatorship ignores that politics will trump legality in a difficult mid-term election cycle should remember that politics are a two way street and the Republicans would make hay with any significant violation of the conservatorship. It is in large measure the public’s weariness from random interventions into market function and ineffective programs which continue to advantage banks ahead of market participants and the real economy that have caused so much unhappiness with this Administration. A new and massive program that crams losses onto investors rather than addressing fundamental problem3 will not be well received.

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Previously:
Morgan Stanley: More Irresponsible Mortgage Lending, Please (July 28, 2010)

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1 Note: The Special Inspector General for TARP, in his Quarterly Report to Congress states “PRA does not require servicers to forgive principal, even when doing so is deemed to offer greater financial benefit to the investor.”

2 https://www.hmpadmin.com/portal/docs/hamp_servicer/praoverviewnongse.pdf

3 http://bradmiller.house.gov/index.cfm?sectionid=53&sectiontree=46,53&itemid=928

Category: Credit, Real Estate, Really, really bad calls, Research

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

27 Responses to “Refi Madness: The Heat is Frying your Brain (Redux)”

  1. A few other people discuss the unlikeliness of this :

    Barron Randall Forsyth
    Mortgage Forgiveness? Forget It
    http://online.barrons.com/article/SB50001424052970203667404575412951885388376.html

    Calculated Risk
    Nonsense Rumor on Fannie and Freddie
    http://www.calculatedriskblog.com/2010/08/nonsense-rumor-on-fannie-and-freddie.html

    Morgan Stanley: More Irresponsible Mortgage Lending, Please
    http://www.ritholtz.com/blog/2010/07/morgan-stanley-more-irresponsible-mortgage-lending-please/

  2. Petey Wheatstraw says:

    It’s been at least 3 years since I started posting this comment, an it is as true now as it ever was: Our two choices are default or inflate (and by “inflate,” I mean income inflation to the bottom 80 (indebted) percent). There will be no “working” our way out of this. To continue trying to support the structure that crushes us is irrational and will lead to negative social consequences unanticipated by our current government and/or electorate (the latter being the vestigial tail of our former incarnation as a functioning Democratic Republic).

    Glen Greenwald at Salon has some interesting observations on the state of our culture, at Salon:

    http://www.salon.com/news/opinion/glenn_greenwald/2010/08/06/collapse

  3. Petey Wheatstraw says:

    As for mortgages and home “ownership” — Bushco’s American Dream, turned nightmare — it’s a whole new form of Corporatist market manipulation, fully supported by our current Corporatist CEO, Barack Obama.

    Not only has “government” approved marked-to-loan-value accounting fraud distorted the value of our aggregate RE holdings (and indebtedness/solvency), it has resulted in around 90% of all REO properties being held off the market. This distortion in the available supply of housing (regardless of the underlying value of that supply) violates the most basic law of a functional economy. It also disenfranchises the vast majority of the citizenry while further empowering a miniscule group of insulated Corporatist cronies.

    Turns out, the revolution wasn’t televised.

  4. michaelismoe says:

    Of course the refi story was complete bullshit. However the rationale for the story was tried and true – paint the current administration as “socialist” all the while making sure the corporatist underpinnings remain solid and in full force.

  5. Chief Tomahawk says:

    “hair-brained”???

    C’mon! If there wasn’t an element of that vein in our ‘finest’, we’d have never followed The White Rabbit down ‘the hole’ in the first place. Now our ‘brain trust’ has convened a Mad Hatter Tea Party where it’s always Tea (ie. spending) time and deficits don’t matter…

    By the way, we do still make something in America: reams of Wall St. ‘paper’ tied to assets of questionable value, backed by the sovereign credit of the Unied States taxpayer. [Too bad that credit, established by America's Veterans, has been usurped & abused by a bunch of greedy individuals in search of commissions and profits at any cost.]

  6. call me ahab says:

    I prefer reefer madness myself-

    also- BR- as your self appointed editor- please replace “hair-brained” with “hare-brained”-

    and to make my man Hoffer proud-

    http://dictionary.reference.com/browse/hare+brained

  7. rktbrkr says:

    With mid-terms coming up I understand the “don’t just stand there do something” urge. Thus far all the admin’s real estate efforts have been partial or complete flops and the tag team of high unemployment and weak consumer spending seems to be pushing us into a double dip.

    While this plan has a simplistic approach “Since the GSEs are on the hook anyway” refi everyone who is current regardless of LTV it still doesn’t touch the substantial hardcore that is underwater and not current, they are the potential walkaways who will dictate marginal pricing in the short & medium term. If you help those who are current and plan to ride this out then you don’t really reduce the pool of potential short term sellers and walkaways and you might even discourage the underwaters who aren’t current and they will throw in the towel and drop their losers on the market.

    This GSE plan might help current homeowers in recourse states where walkaways aren’t that easy to do. I would hope that if the GSEs offer this very attractive refi break they would write in recourse provisions that supersede individual states non-recourse provision. Not clear if this GSE gifting would be limited to primary residences.

  8. call me ahab says:

    petey/marcus-

    thanks for the link-

    I was just wondering about the whole “decline of America” last night- it was all a dream anyway-

    every time I hear someone say “American exceptionalism”- I want to go medieval on their ass

  9. ruetheday says:

    Lowering the average mortgage interest rate by 150 bp (which is probably overstated, 100 bp is more realistic) will not solve the two fundamental problems – the home price decline that has resulted in millions of homeowners who are underwater on their mortgages by staggering amounts and second, the millions of people who are unemployed and have little or no income from which to make any mortgage payment.

  10. Petey Wheatstraw says:

    ahab,

    No doubt and exactly. Medieval, as in:

    Marsellus Wallace: “What now? Let me tell you what now. I’ma call a coupla hard, pipe-hittin’ niggas, who’ll go to work on the homes here with a pair of pliers and a blow torch. You hear me talkin’, hillbilly boy? I ain’t through with you by a damn sight. I’ma get medieval on your ass.”

    — Pulp Fiction

    Ezekiel 25:17

  11. Lowering monthly mortgage payments by a refinance as described does nothing more than trade a lower mortgage payment for a higher tax bill. It will take a while for the higher tax bill to manifest itself in lowered disposable income, but then, maybe that’s the point.

    Indeed, America is only exceptional by dint of her talents at delusion and rationalization.

  12. cognos says:

    The person who wrote this article should please RESIGN immediately.

    At the least, take 25 lashes and promise to LEARN something about mortgages and the mortgage market before writing an article. There are a DOZEN mistakes and dumb statements here… most egregiously the simple ones like this quote:

    “investors would become EVEN MORE unwilling to invest in MBS gong forward” – (emphasis added)

    HELLO! The MBS market is at ALL TIME tight spreads and low rates. Investor demand for Fanne/Freddie passthroughs is enormous. And really this is true of all “spread product” and rate product generally. HY bonds have returned 8% ytd after a great 2009. Mortgage credit bonds have returned 10-100% ytd with the lowest credit tranches going parabolic and many up 200-500% off bottoms.

    (I know you guys probably miss me. Read mostly through the “Pulse” app on iPhone/iPad these days. Its fantastic.)

  13. cognos says:

    PS – Its really tragic that home mortgage payers cannot refi. Its also tragic that they cannot simply reduce the mortgage by 10-20-30% where appropriate.

    With all the legal costs, auction costs, and time value costs… the “mortgage holder” collects abotu 20-30 cents on the dollar in a ‘foreclosure’. THEREFORE, if we could simply drop interest to 3.25% (5/1 ARM) and reduce principal by 20% for the right mortgages… EVERYONE wins. It truly is that simple.

    The problem lies in a) who is the decision maker, when everything is securitized? and b) avoiding fraud.

    But these problems are NOT economic problems. (PPS — this problem is mainly worked through. It just tragic we did not confront it in a better way 2 years ago. Ah. the big winners are the foreclosure buyers some of whom own 100s or even 1,000s of homes bought at 25% of peak prices and now renting for 10% carry against 3-4% financing.)

  14. Petey Wheatstraw says:

    cognose:

    Your first and second comments are either contradictory or they lead to big problems with your high performance, high yielding MBS/bonds/derivatives/exotically-named vehicles for the perpetuation of fraud, in the near future.

    It’s also strange that you would seek to have fraud, moving forward, eliminated from the system, while, at the same time, championing “gains” from fraudulently created and valued “securities” currently being traded at fraudulent prices/values.

    Your investing scheme depends on fraud. Hope that keeps working for ya’.

  15. louis says:

    It is the strategic defaulters with jobs and pristine payments that you need to get to, A plan to suspend appraisal and refi to current rates will keep those from creating the shadow inventory. The people who cannot pay even after a refi are the ones that need to be purged.

    The debtor has the final word in this, better get to the ones who have attorney friends first and get their brains off the concept of strategic default.

  16. Mike in Nola says:

    Bruce Krasting has a post over on ZH which says there actually is such a program, based on a statement from the FHA, but the conditions make it unlikely that many will qualify:

    http://www.zerohedge.com/article/rumors-news-news-rumors

  17. DeDude says:

    Yes investors and municipalities would lose some “sucking” on these homeowners. Problem is you can only squeeze so much water out of a stone – and this is in part meant as a way to keep people in their homes and avoiding the much bigger loss of jinglemail (not killing the golden goose).

  18. Mannwich says:

    @Petey: But isn’t fraud now the very basis of the entire system that allows the cognoses of the world to “thrive”? Of course he’s OK with it. He’s not only OK with it, he LOVES it. It allows the money changers like him to reap the benefits.

  19. Petey Wheatstraw says:

    Manny:

    that’s right. But it doesn’t mean he should be treated as a respectable member of society.

    Dude is a leach attached to the vampire squid.

  20. X on the MTA says:

    Josh, here is my response

    Here’s the gist of it:

    Oh, no! The government would stop subsidizing people earning abnormally high yields with unusually low prepayment rates! Shut up, Josh. Anyone who bought MBS in size knows that there is an embedded call option in the loans and how negative convexity works against you when interest rates drop.

    I was under the impression that the government was trying to get out of the business of subsidizing bond holders at the expense of everyone else. I’m sure investors find new ways to reach for yield or invest that money in, oh, I don’t know, a value-creating process?

  21. X on the MTA says:

    Yeah, what @cognos said. Totally.

    If your collateral is worth less than the loan it is in the interest of the lenders to increase the quality of the borrower and therefore the quality of the loan.

  22. johntlg says:

    Wonder what would have happened/ will happen if they approached underwriting guidelines on a transaction based on whether it was a purchase or refi. It has become significantly more difficult to qualify borrowers due to DTI ratios avobe 45-50% and of course the dreaded valuation process. FNMA dropped their top threshold down to 45%; 50% w/ compensating factors (good assets).

    What if all refis were allowed through the system, shift the DTIs caps to 65%, as long as the borrower has not had any lates in the past 12-24 months.

    UW guidelines were tightened across the board; they should have made purchase transactions qual on tighter guidelines while alllowing refis to get through for borrowers w/ a proven trackrecord. They wouldn’t have had to create all these “4 letter word” programs that have provided little relief.

  23. d4winds says:

    I want to be on the short side of anyone who believes this.

  24. ToNYC says:

    DOA..the giver or the taker.

  25. economicsfan says:

    How about a bailout for GenX’ers and GenY’ers? Specifically a student loan debt bailout. The financial system bailout and this proposed homeowner bailout primarily use borrowed money to help affluent and/or imprudent baby-boomers. Their children and grandchildren will have to repay that money. I propose changing the bankruptcy laws so that student loan debt could be discharged in bankruptcy. That way younger people who have incurred tens of thousands of dollars in student loan debt only to find that boomer-run corporations have outsourced the jobs they had trained for would be able to get a fresh start. Boomers have been able to get fresh starts by walking away from their mortgages and declaring bankruptcy and now there is talk of mortgage principal reduction. A student loan debt bailout would be very bad for the federal debt but at least those who are going to have to repay that debt would get the benefit of the bailout.

  26. Petey Wheatstraw says:

    economicsfan:

    Non-dischargeable debt is the key to Corporatist hegemony. It creates debt slaves. It fosters high risk lending and borrowing practices. Bankruptcy reform — the result of which was to make the discharge of debt more difficult — was a large step towards this ultimate goal of the Corporatist regime.

    This chart speaks volumes:

    http://rortybomb.files.wordpress.com/2009/09/bankruptcy_filings.jpg

    It’s what we voted for, it’s what we got (we don’t own it, it owns us).

    Maybe it’s the fluoride.

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