The Administration’s newly announced plan to provide low cost refinancings to underwater, current borrowers whose residential mortgage loans are not owned or securitized by the GSEs is high on hope and low on likelihood of success. The plan creates a form of a “streamlined” refinancing on a stated income basis and without an appraisal. Eligibility criteria include that the loan to be refinanced has been current for the past six months, the borrower must meet a minimum credit score of 580 and be an owner-occupant and the new loan must fall within FHA loan limits and a to-be-determined high loan to value ratio. Holders may need to write down principal of the existing loan if the LTV exceeds a certain percentage in excess of 100%, much like the wildly unsuccessful 2010 FHA Short Refinance program.
While this program is to be administered by the FHA, it is not at all clear that the loans will be insured by the FHA. On one hand, the announcement states that a separate fund will be established in addition to the existing Mutual Mortgage Insurance Fund to better track and manage the risk involved, which strongly suggests that the loans will be insured by the FHA. On the other hand, no mention of a mortgage insurance premium paid by the borrower is made in the announcement. Estimating the cost of the plan to be in the range of $5 billion to $10 billion, the Administration explains that the cost will be fully offset by using a portion of the Proposed Crisis Responsibility Fee (the “Tax”) and the program will not increase the deficit.
President Obama first proposed the Tax in 2010 in his State of the Union Address. He called for the nation’s largest banks with assets in excess of $50 billion to pay the Tax in consideration of the government bailout that they previously had received. The proposed Tax never went anywhere following the speech.
It is not likely that this program will be enacted by Congress in its current iteration. First, stated income loans without appraisals would be deemed an unsafe and unsound banking practice, if not a predatory practice, by most regulators these days. The reason that the FHA and the GSEs can operate such programs under their respective streamlined refi programs without criticism is that they already own the risk of loss from a borrower default, regardless of the borrower’s current financial circumstances or the current value of the property, and they can reduce this risk of loss by reducing the borrower’s interest rate. In this case, though, no government agency or instrumentality presently bears the risk of loss on the underwater loans owned by private investors. Thus, one would think that there would be serious questions about the assumption of the risk of loss on underwater loans without verifying a borrower’s income or the current market value of the property.
Second, there is no realistic way to fund the program’s heightened risk of loss. The Administration appears not to be worried about the issue because it believes it indirectly can transfer the risk of loss to the big bad banks who would be required to pay the proposed Tax. Since it is very unlikely that such a targeted tax will be passed by Congress and imposed on banks, you can assume that this proposal has no real funding source. That would leave the risk of loss to mortgage insurance premiums or Congressional appropriations. Third, for high LTV loans, it is not likely that holders of current loans will agree to permanent principal write downs, and they probably can’t agree to such write downs if the loans are held in private securities. Fourth, if the loan is insured by FHA, one should assume that insured lenders would be subject to tremendous scrutiny by the FHA if the loans were to default and so lenders may not be rushing to make high, LTV stated income loans. Financial institutions presently are experiencing the consequences of manufacturing to the stated income specs of investors and insurers, and it is not a pretty sight. One should assume that FHA will forget the embedded risk in these loans and seek to transfer the risk of loss to originating lenders if and when the loans default and holders seek to convey REO with values significantly less than the amount of the claim for insurance benefits.
The problem of current, underwater borrowers is real. Unfortunately, this proposed approach is largely illusory. The only likely result is the creation of unrealistic expectations of current borrowers who desperately want to take advantage of the low market interest rates.