When Obama delivered his jobs speech about a week ago he dropped a hint about a proposed program to work with federal agencies to help responsible, underwater homeowners refinance their mortgages. As he described it this would “put more than $2,000 a year in a family’s pocket, and give a lift to an economy still burdened by the drop in housing prices.” The reason these people need help to refinance is that no new lender is going to give these homeowners a new loan for more than what their home is currently worth - and that's what it is going to take to pay off their current higher rate mortgage.
Giving distressed homeowners help sounds great, right? Let's give every underwater homeowner $2,000 per year. While we are at it let's give everyone a BMW. But let's face it (almost) everyone knows there's no such thing as a free lunch. You can't just create $2,000 out of thin air. So how is a program like this going to work? Well, I finally had the time to dig around and I found this Congressional Budget Office 31 page working paper that was released just a couple of days before Obama's speech and it provides an analysis of large scale mortgage refinance programs.
There Are Real Costs To A Mortgage Refinance Program
There are two key gotchas in this analysis. First is the cost to the government - or Fannie Mae and Freddie Mac. Not until page 20 do they finally get around to discussing this. They claim that it will only cost $600 MM but this number includes magic savings of $3.9 B that supposedly will result from fewer defaults. The logic is that some people who have already been paying their mortgage off are at risk of eventual default because their rate is too high.
Huh? But these people are already paying off their mortgages and their rates aren't that high by historic standards. And I have yet to meet with prospective sellers whose decision on a strategic default has anything to do with their mortgage rate. It's all about a new job or a new kid or just getting tired of the old place. So these are probably just fictitious savings and the real cost to the government is going to be $4.5 B.
But then there is the real kicker to this program that they don't get to until page 23 and it's the cost to investors - and we're talking about people like you and me. You see these mortgages that are about to be refinanced are owned by regular people (not just "millionaires and billionaires") through real estate investment trusts and pension plans.Well, this study estimates that this program will cost these people between $13 - 15 B.
But How Do Refinancings Cost Investors Money?
In case you are wondering about this let's sidetrack for a minute. The value of these mortgage investments is determined by how much interest they earn and for how long. If suddenly their life is cut short because of a refinancing the investors, who may have just bought a package of mortgages or a REIT yesterday, suddenly own something worth less than it was the day before. So what you are really talking about with this program is a huge wealth transfer from investors and lenders to homeowners - and let's not forget that this whole housing bubble has already resulted in a huge wealth transfer from investors to homeowners since homeowners were able to buy bigger and better homes than they could really afford at the expense of the investors who are now left holding the bag.
But There Are Even More Costs To This Mortgage Refinancing Program
I didn't see this paper address the inherent cost to lenders or government insurers of loaning more money to a homeowner than their home is worth (at least up to 25% more and there are proposals to raise that limit) at the lowest rates. At least the current lenders are getting a higher rate that partially compensates them for the added risk of holding an underwater mortgage. Isn't a big part of our current problem that too many people borrowed 100% of the value of their homes? Admittedly I just skimmed this 31 page paper so if you find that I missed something please let me know.
Then there is the especially insidious issue that when the government is in the habit of pulling the rug out from underneath a lender or an investor at any moment those lenders and investors become reluctant to participate in the market going forward - unless they get paid more for taking on government craziness risk. So costs could very well go up for all borrowers in the future.
You see...you just can't repeal the laws of economics. They will bite you in the ass every time.