Obama Administration
Housing Initiatives
Douglas J. Elliott
July 2, 2009
1
Agenda
• The problem
• Alternative solutions
• Approach of the Obama Administration
• Progress report
• Issues for the future
Douglas J. Elliott
delliott@brookings.edu
2
The Problem
•
Delinquency rates on mortgages are very high and
rising
•
House prices have plummeted by 32% from their
peak and are forecast to fall further
•
19% of mortgages are underwater. 1 in 10 borrowers
were underwater by at least 10% as of the end of
2008
•
Unemployment rate is 9.4% and will likely peak over
10%
•
As a result of these factors, a high proportion of
delinquent mortgages are likely to default
Sources: S&P/Case-Shiller Composite-20 Home Price Index; Moody’s Economy; First American Corelogic; Bureau of
Labor Statistics
Douglas J. Elliott
delliott@brookings.edu
3
Delinquency rates are very high
and rising
Mortgage Delinquency Rates
30
25
20
1st Qtr 2008
15
4th Qtr 2008
1st Qtr 2009
10
5
0
All Mortgages
Prime
Subprime
Source: Mortgage Bankers Association National Delinquency Survey, seasonally-adjusted 30-day delinquency rates;
Alt-A loans are split between prime and subprime based on self-reporting by survey respondents
Douglas J. Elliott
delliott@brookings.edu
Jan-00
Douglas J. Elliott
delliott@brookings.edu
Jan-09
Oct-08
Jul-08
Apr-08
Jan-08
Oct-07
Jul-07
Apr-07
Jan-07
Oct-06
Jul-06
Apr-06
Jan-06
Oct-05
Jul-05
Apr-05
Jan-05
Oct-04
Jul-04
Apr-04
Jan-04
Oct-03
Jul-03
Apr-03
Jan-03
Oct-02
Jul-02
Apr-02
Jan-02
Oct-01
Jul-01
Apr-01
Jan-01
Oct-00
Jul-00
Apr-00
4
House prices have plummeted by
32% from their peak
S&P/Case-Shiller Home Price Index
250.00
200.00
150.00
Composite-10
100.00
Composite-20
50.00
0.00
5
Some alternative solutions are
undesirable or appear infeasible
• Directly intervene to raise house prices
»
Very expensive
»
Hard to implement
»
Works against market forces finding a new equilibrium
• Subsidize income of borrowers
»
Very expensive
»
Raises fairness issues
Douglas J. Elliott
delliott@brookings.edu
6
Infeasible Solutions, cont’d
•
•
Let foreclosures occur and cushion the rest of the economy
»
Foreclosure process is expensive, traumatic, and damages confidence
in the economy
»
Toxic assets tied to mortgages are very difficult to handle
»
Public and politicians demand relief for homeowners to balance bank
rescues
Force the mortgage holders to restructure the loans
»
May violate the “takings” clause of the Constitution
»
Securitization makes implementation difficult
»
Would probably damage already-weakened banks that rely on
government aid
»
Difficult for the government to determine the right restructuring formula
Douglas J. Elliott
delliott@brookings.edu
7
Main alternatives center on
subsidizing restructurings
• Both the Bush and Obama Administrations
subsidized mortgage restructurings
• Interest subsidies are designed to deal with
cash flow problems of homeowners
• Subsidizing principal reductions
»
Would get at true solvency issues
»
Would create economic incentives for those whose
mortgages are significantly underwater
Douglas J. Elliott
delliott@brookings.edu
8
One potential nightmare: What if
homeowners start behaving rationally?
•
Homeowners generally try hard to hang onto their
homes, even when their mortgages are underwater
»
•
Recent FRB Boston paper found that “less than 10 percent of a group of
homeowners likely to have had negative equity eventually defaulted on their
mortgages”
There are likely to be four main reasons for this
»
Desire to preserve credit ratings
»
Wanting to remain in their family home
»
A desire to do “the right thing,” avoiding the shame of foreclosure
»
Value of option on future price appreciation of the house
Sources: Foote, Christopher, Kristopher Gerardi, and Paul Willen. “Negative Equity and Foreclosure: Theory and
Evidence.” 2008 FRB of Boston Public Policy Discussion Paper No. 08-3.
Douglas J. Elliott
delliott@brookings.edu
9
Nightmare, cont’d
• But, we have never had so many homeowners
so far underwater on their mortgages
• What happens if the culture and environment
change?
»
Credit providers may stop giving as much weight to
foreclosures.
»
Worse, individuals may stop feeling virtuous for
continuing to pay on underwater mortgages and may
start to feel like fools when they see neighbors just
turning in the keys
Douglas J. Elliott
delliott@brookings.edu
10
Make Home Affordable Program
•
Refinance
»
•
Homeowners with conforming loans with up to 105% Loan to
Value (LTV) ratio can refinance at better rates
Modification
»
Lenders, servicers, and borrowers given incentives to lower
monthly payments to 31% of income
–
Lender reduces payments to 38% of income, government matches
further reductions to 31%
–
First, through interest reduction, then longer amortization, then
principal reduction
–
“Pay for success”: Servicers get $1,000 for each modification, and
additional $1,000 per year for 3 years if borrowers stay in program
Douglas J. Elliott
delliott@brookings.edu
11
Make Home Affordable, cont’d
•
•
Additional incentives for borrowers to stay current
»
$1,500 for borrower, $500 for servicer if modification is made while current
»
$1,000 principal reduction for borrower each year for 5 years if they stay current
Servicers are encouraged to pursue alternatives to bankruptcy
(deeds-in-lieu, short sales)
»
Servicers get $1,000 for successful D-I-L or short sale
»
Borrowers get $1,500 for relocation costs
•
Judicial “cramdowns” of principal in bankruptcy proposed
•
Industry-wide guidelines specified to reduce fear of lawsuits and
clarify restructuring process
Douglas J. Elliott
delliott@brookings.edu
12
Progress Report
•
It is too early to assess the effectiveness of the plan
•
14 servicers, including major ones, are signed up
•
About 50,000 trial mortgage modifications have been
performed, out of long-term target of 3-4 million
•
Roughly 100,000 applications have been received
•
At the least this is better than the ONE loan modified
under the earlier Hope for Homeowners plan
Douglas J. Elliott
delliott@brookings.edu
13
Issues for the future
•
How many loan modifications will be done? Biggest risk
may be that interest rate reductions alone are insufficient to
motivate enough homeowners, if solvency is the real issue
•
What will the redefault rate be? Earlier programs
involving interest rate reductions alone had a poor record,
but they had often resulted in HIGHER monthly payments
through fees and rolling past unpaid interest into principal
•
Will principal reductions be essential? It appears that
principal reductions make more of a difference, and may be
the only way to deal with mortgages that are significantly
underwater. However, lenders and servicers have been
reluctant. Sharing in future appreciation may help, but is
complicated
Douglas J. Elliott
delliott@brookings.edu
14
Issues, cont’d
• What can be done for homeowners with
Option ARMs mortgages? Their interest rates
are already low at this point, so interest rate
reduction has little effect in the near-term
• What can be done for the unemployed? They
need more help now, but may be able to make
mortgage payments again later on. Unfortunately,
targeting the unemployed could have undesirable
labor force effects
Douglas J. Elliott
delliott@brookings.edu