Follow up: Refinance America: A New and Improved Plan

In a recently published study by the Federal Reserve they confirm what millions of American homeowners know first hand and what most professionals in the housing finance industry have known for over a year:  namely, that millions of  American homes are unable to be refinanced - despite historically low interest rates - due largely to the fact that many of these homes are either underwater (meaning the current loans balance exceeds the current property value) or the home's owners fail to qualify for refinance loans due to tighter credit standards. The Fed's study would suggest that at least two million American homes are eligible for refinance but for these conditions.

Despite this reality, Washington seems unable to come up with a solution. Prior efforts such as HARP (Home Affordable Refinance Program), though well intentioned, quite frankly have failed.  The failure is due in no small part to the fact that the eligibility criteria designed by regulators have been too narrowly defined to accommodate a housing market where values continue to decline and an economy that remains weak at best. 

And though efforts are currently underway to design and implement a new refinance program, it is likely that this effort to will fail.  Why? Because Washington wants to put strict conditions on who will qualify for a refinance loan for fear of being accused of encouraging "moral hazard" where certain unworthy home owners benefit from the redesigned refinance program. The details of the "new" refinance program have not yet been published and no deadlines have yet been set for its implementation. As a result, millions of American home owners - most of whom are current on their mortgages, by the way - continue to twist in the wind as interest rates hit new lows nearly every day.

By contrast, I believe it is possible to implement a meaningful refinance program by year-end that is simple to implement, rewards every American that remains current on their mortgage, poses very little risk to encouraging moral hazard, and, most importantly, will inject billions of dollars of free cash flow into our struggling economy. 

Here's how it would work:

  • Mortgage borrowers current on their mortgage for the past 12 months and whose new payment would be at least $50 dollars per month less than their current payment qualify. Period!
  • To be clear, this would apply to borrowers who are owner occupants and investors alike. Moreover, the program would apply to borrowers' with first and second mortgages as well. If the new payment is less than the combined old payments, they get rolled up and refinanced into a new loan under this program. It's that simple.

Detractors will surely say "... Oh my God, it can't be that simple, what about loan-to-value ratios, what about credit scores, what about current employment and income, what about investors who lied on their prior loan applications, what about..., what about ..."  To those detractors I say, who cares?  If the goal is to enable American homeowners to take advantage of current interest rates, reduce their current payments and therefore free up cash for use in other parts of the American economy, then why not let them refinance. 

For God's sake, let's be honest, if someone is managing to make their mortgage payment today at a higher rate - regardless of loan to value, regardless of whether they are employed or have a nickel of savings - then the odds are pretty darn high that they will continue to make their payment if the payment drops. 

Of course, nothing is ever this simple, and lenders in today's business environment  - where their business decisions are being scrutinized at every turn - likely would be very reluctant to originate loans under this limited guideline for fear that in the future some regulator or politician would challenge their lending decision as somehow imprudent.  They also would likely reasonably fear holding these loans on their balance sheets given the implications of such loans to their future financial condition and regulatory capital requirements, among other things.

And undoubtedly, operational bottlenecks from overtaxed servicing and origination platforms will be an issue for the implementation of any sort of plan. However, innovative private sector service providers and solutions exist today to help unburden those organizations and streamline this proposed refinance process.  In fact, under one such solution, the process could be as simple as to only require that borrowers execute a new note or a rider to their existing note.

Even under the most streamlined scenario, however, to make this work - and it can work, the following also would be required:

  1. This limited guideline would need to be memorialized into a new loan program and published by FHA or Fannie and Freddie (or both);
  2. The program should be available only for a limited period  - say for the next twelve (12) months - in recognition of the fact that lenders are already backlogged with refinance requests;
  3. The guideline would need to make clear that the lenders' only repurchase - or rep and warrant obligation to FHA, Fannie or Freddie - would involve the determination of whether the borrower had been current the past 12 months and whether the new loan payment was lower than the old loan(s). Likewise, large lenders could not impose more onerous rep and warrant standards on smaller lenders originating these loans and from whom they might buy these refinance loans.
  4. Regulators would need to affirm that lenders' capital or reserve requirements would not need to be increased in any way to account for the unique underwriting characteristics of the loans originated under this program.
  5. A new liquidity mechanism would need to be developed so these loans could be sold by the lenders originating them. For this, we believe that Ginnie Mae should create a new Ginnie III security designed specifically for these loans.  By doing this, the securities would enjoy the full faith and credit of the US Government and would be readily purchased by investors, including foreign ones.

The benefits of such a program if successfully implemented could be significant both to the housing industry and the American economy:

First, for homeowners whose monthly payments would be reduced, that lower payment would function like an immediate tax cut - Americans' spending power would improve immediately - but with no negative implications to the federal budget;

Second, investors (bondholders), who have interests in the loans being paid off by these refinance loans, would be satisfied at par (or 100%) - though perhaps earlier than they might have otherwise.  However, that is a far better outcome than a situation involving government-sanctioned principal reductions - which in my opinion is nothing less than a government-sanctioned abrogation of contract - and the greatest example of moral hazard - and to be avoided at all costs.

And on that point, let me say, that there should be no government-sanctioned principal reductions under any circumstances. That should be avoided under all circumstances - even where a default and foreclosure would result.

Third, the cost to the government would be virtually zero. Costs would be conditional and would be recognized by the government if and only if borrowers whose loans were refinanced under the program defaulted. To be clear, that is a risk the government already has through its support of Fannie, Freddie, FHA and Ginnie Mae. Surely, it makes sense to reduce that risk by lowering millions of borrowers' mortgage costs thereby reducing their likelihood of default.

Fourth, and most importantly, but perhaps most intangible, this program would revitalize consumer confidence at a time when it most needs encouragement. It would reward those homeowners who, despite all of their challenges and difficulties, have found a way to keep making their mortgage payments. 

If these aren't the people we should be helping, I don't know who is.