David Coates

The Housing Policy in 2009

The Obama administration moved quickly to help American families remortgage their houses and avoid foreclosure.

  • On February 19 it put aside $75 billion of the bank bailout fund to help 4 million homeowners renegotiate their primary mortgages by giving financial incentives to lenders to modify loan terms and by subsidizing the borrowers’ interest payments over a five year period. (The target here was to get mortgage payments down first to 38% of monthly income, and then to 31%.) To encourage bank participation, the administration backed a legal change allowing courts to modify mortgage terms if voluntary agreement fails. It also allowed mortgage holders whose mortgages are backed by the GSEs – roughly one mortgage in two – to refinance at lower rates even if the mortgage holders have less than 20% equity in their property, but only if their mortgages were no more than 105% of their property’s value.. That was said to potentially aid another 5 million mortgage holders.
  • The administration also put an extra $200 billion into Fannie Mae and Freddie Mac, to enable them to increase credit for mortgages generally. It was a plan built on the recognition that Fannie and Freddie would probably stack up losses of $65 billion from the $200 billion given them in September 2008 – hence the doubling of the amount federal authorities would reimburse them to cover mortgage losses. Putting confidence back into mortgage lending was a core concern of the Obama rescue package. Effectively the 2 GSEs were absorbed into the federal government by the Obama administration, and instructed to oversee a huge mortgage modification program, to buy greater numbers of loans, and to refinance millions of at-risk homeowners. The long term fate of the 2 GSE’s remained in discussion within the administration through the summer, with reports circulating of the possible creation of a government-backed “bad bank” into which Fannie and Freddie would be able to off-load their most troubled loans. Then, on Christmas Eve, the Treasury quietly announced that it would provide unlimited financial assistance to both Fannie Mae and Freddie Mac, effectively removing the $400 billion cap on emergency aid. The Obama administration is due to announce in February 2010 its long term plans for the two GSE’s. By promising to keep the two companies solvent, the administration “can maintain its sweeping power over the housing market. Fannie Mae and Freddie Mac have played a central role in Obama administration policies to keep mortgage interest rates low, restructure unaffordable mortgages, stop foreclosures and funnel money to housing programs around the country.” (The Washington Post, December 25 2009)

The Obama Home Affordable Modification Program (HAMP), though unprecedented in its scale, was slow to be implemented (only 650,994 loans had been modified by as late as Veterans Day 2009). It also initially still left unassisted probably 13-15 million mortgage owners who were financially solvent but currently had mortgage balances bigger than the reduced value of their properties. (JP Morgan estimated that 20% of the US’s 50 million mortgage owners owed more than 105% of the value of their house, and so did not qualify for help under the plan). It also offered nothing to those pushed into bankruptcy (and the danger of foreclosure) by the weight of their second mortgage. It was a plan based on the premise that the root of the foreclosure crisis was the burden of the monthly payment, not the burden of negative equity. What the plan did not initially do was address the plight of homeowners with negative equity by reducing their loan’s principal balance. Yet as the recession deepened and unemployment spread, vulnerability to foreclosure because of lack of home equity was bound to intensify.

· By August the generally accepted estimate was that foreclosures (often triggered by unemployment) would be around 1.8 million in 2009 (as against 1.4 million in 2008); as one in eight US mortgage payers – 6 million in total – were by then behind on their payments or facing foreclosure (The Financial Times August 21, 2009).

· By July the administration’s instructions to the 2 GSE’s had accordingly been reset, to allow refinancing of mortgages that were up to 25% higher than the current value of the property mortgaged; and banks came under increasing pressure to include principal modification in their negotiations with over-stretched mortgage holders,

In the second quarter of 2009, the proportion of loan modifications that included some reduction in the principal owed, though still very much the exception to the rule, had risen to 10% of all mortgage loans modified (The Wall Street Journal, October 1 2009). It remained the case, that in November “about one in seven American households with mortgages [were] behind on payment or in foreclosure, according to new data from the Mortgage Bankers Association. That [was] up from about one in ten a year ago.”(This from The Wall Street Journal, November 20 2009). The paper reported fears of what it called a “double dip in housing”, as 3.4% of all US households – 1.9 million in total – were reportedly 120 days or more behind on their mortgage payments, foreshadowing a further round of foreclosures to come in 2010.

Nor did the original Obama plan immediately impact on the construction industry. New house starts in the US in April were the lowest since 1959 – 54.2% down on start in April 2008, and a clear 50-year low. House prices ,meanwhile, varied significantly across the US as a whole: with prices down 32.4% on the year in Las Vegas and 26.4% in Los Angeles, but only down 9.1% in New York and 6.9% in Charlotte North Carolina (The Financial Times, April 22 2009). From a construction industry awash with demand, the US house building sector in 2009 found itself awash with supply, and threatened with the possibilities of ever larger numbers of bank repossessed houses entering the market as the foreclosure tsunami, delayed but not destroyed by the HAMP initiative, gathered renewed strength in 2010 and 2011. As Jay Brinkman, chief economist at the Mortgage Bankers Association, put it.

There has been a shift in the problem from one driven by the types of loans to one driven by macro problems in the economy and drops in house prices. It’s unlikely we will see meaningful reductions in the foreclosure and delinquency rates until the employment situation improves.” (The Financial Times, August 21 2009)

The shock of the lax sub-prime accounting standards triggered in 2009 exactly its reverse: a general move back towards requirements of 20% deposits and a lower proportion of salary allowed for mortgage payment – a reversal of the “democratization of credit” that had been such a feature of the sub-prime years. Getting a mortgage in 2009 became very difficult indeed. 90% of all new mortgages in 2009 were funded or guaranteed by taxpayers, and as many as one-third of those obtaining mortgages in the boom years (2005-6) would likely not qualify for a mortgage now. This, in spite of renewed activity by the Federal Reserve (buying up mortgage backed securities with the aim of eventually owning $1.25 trillion worth), a policy designed to keep mortgage interest rates low. (As late as September 23, the FED was reconfirming its commitment to sustaining this policy right up to the $1.35 trillion, before eventually carefully phasing it out). An earlier end to that policy might have reduced the demand for housing by anything up to 20% (The Wall Street Journal, September 24 209).

Add in too extra underwriting of mortgages by the FHA – the other source of government support for home loans alongside Fannie and Freddie and the one with traditionally lower requirements for mortgage security The FHA’s problem, however, was that its losses too were rapidly mounting – nearly 8% of its loans were in arrears or foreclosure by the end of June, and the agency is now expecting a 24% default rate on loans made in 2007 and a 20% default rate on loans made in 2008 (The Wall Street Journal, November 4 2009) – and it was accordingly rapidly running out of reserves it had built up steadily since 1992, when premiums collected regularly exceeded its liabilities. Freddie Mac’s 2009 losses (quarters 1-3) are reportedly running at $7.6 billion; Fannie Mae’s are larger, at $22 billion (The Wall Street Journal November 7-8, 2009). By November, the FHA was projecting running out of capital in 2011 if the recession persisted, and was tightening its loan standards (The New York Times, November 13 2009). “It also reported that its reserves for unexpected loan losses would fall short of the required 2% level this fall.” (The Wall Street Journal, November 13 2009)

In parallel moves, the House and Senate began to consider legislation enabling foreclosed homeowner to remain in their houses as renter on long term leases, if banks could be persuaded to agree. Such a proposal passed the House on a voice vote late in July, and Fannie Mae announced such a policy in November. Homeowners facing foreclosure on mortgages it underwrites will now be able to stay in their homes and rent them for as long as a year. Also in November, Congress voted to extend the $8000 tax credit given to first-time home buyers – to extend it both in time (it was due to expire) through to April and in coverage (to take in all home owners making a new house purchase).

The Center for Public Integrity reported that, of the top 25 financial institutions receiving financial incentives to help troubled borrowers, 21 were major players in the pre-2008 sub-prime loan debacle! (John Dunbar, You Broke It. You Fix It? The Center for Public Integrity, August 26 2009). The Congressional Oversight Panel, created in 2008 and charged with monitoring the use of bailout funds, reported in October 2009 that HAMP was insufficiently robust as to prevent millions of Americans losing their homes: “in the best case” scenario, it said, the program would prevent “fewer than half of the predicted foreclosures.” Out of date already as new economic forces compounded the initial sub-prime foreclosure crisis, the panel urged the Treasury “to reconsider the scope, scalability and permanence of the programs designed to minimize the economic impact of foreclosures and consider whether new programs or program enhancements could be adopted”. (The New York Times, October 10 2009). As the COP chairwomen, Elizabeth Warren, put it:

“Even when Treasury programs are running at full speed, foreclosures are estimated to outpace modifications by about two to one. It simply isn’t clear that the programs in place will do enough to tame the crisis and have a significant impact on the broader economy.”

(The following extract from the draft of Answering Forward, the planned sequel to Answering Back, may be of interest)

The housing crisis deepened rather than eased on Obama’s watch, his solutions at best having only a very limited impact on the problems facing more and more US house-owners, and at worst compounded the problems that his policies were supposed to redress. (It is worth noting in passing that several of the firms heavily involved in subprime lending were also heavily involved in receiving public funds designed to redress the crisis they helped to create.) As late as September 2009 fewer than 5% of the borrowers participating in the administration’s foreclosure prevention program – just 31,000 people – had received permanent loan modifications; that in a national housing market in which house prices were down 40% on average from their 2006 peak, 23% (10.7 million) households had negative equity, more than 7 million households were behind on mortgage payments or facing foreclosure (one in eight borrowers), and a further 2.4 million foreclosures were expected in 2010 among households already more than 90 days behind on their payments. A year into his administration, with the Federal Reserve coming to the end of its planned purchase of mortgages and the Treasury already running down its programs of temporary mortgage relief, fears of an impending mortgage rate hike intensified at the very moment when involuntary unemployment, not subprime excess, took over as the main cause of people’s inability to maintain their mortgage payments. Rates of personal bankruptcy, up 32% nationally in 2009 over 2008, were up by twice that rate in states hardest hit by the falling value of their housing stock. The figure for Arizona, for example, for 2009 was a 79.6% rise in personal bankruptcies in just one year. 31,000 people permanently helped was literally a drop in the ocean, almost offensive in its triviality, as the threat of a second foreclosure spike left literally millions of Americans in danger of losing their homes……

….Obama’s concern to avoid moral hazard issues restricted his capacity to get fully to grips with the scale of the foreclosure crisis. The February 2009 plan that focused on the funding of temporary interest rate reductions and the incentivizing of loan term restructuring did nothing to save millions of American home owners from the reality of negative equity and a new round of foreclosures. Things that could have been done were not done. America’s bankruptcy laws were not reformed. The use of federal dollars to create temporary co-ownership of housing – to parallel the co-ownership of financial institutions and car firms – was not contemplated. Instead the very architecture of US housing finance that had created the crisis was left intact to guarantee further rounds of housing misery to come As Robert Reich observed in 2009, “American bankruptcy law does not allow homeowners to declare bankruptcy and have their mortgages reorganized. If it did, homeowners would have more bargaining power to renegotiate with banks” ( Robert Reich, “Why Obama must take on Wall Street”, The Financial Times, January 13, 2010) which is presumably why Wall Street has been so set against it, and the Obama administration so inert. The administration was at least advised to go the co-ownership route – no less a body than the Federal Reserve Bank of Boston, among others, arguing in June 2009 for direct action to reduce the principal owed on mortgages with negative equity, and a temporary program of loans and grants to help unemployed workers stay in the their homes.( See the editorial, ‘No End in Sight”, The New York Times, June 2 2009) Unfortunately it was advice that in 2009 the Obama administration chose not to take. The foreclosure pipeline was temporarily slowed by the Obama initiative, but his reforms did nothing to seal it: at best, because of it, people were left temporarily in houses that ultimately they would not be able to afford to retain. (Peter S. Goodman, “US Loan Effort is Seen as Adding to Housing Woes”, The New York Times, January 2, 2010) As the Congressional Budget Office concluded as early as October 2009, the Obama reforms would “in the best case, prevent fewer than half of the predicted foreclosures”, not least because the administration’s plans seem “targeted at the housing crisis as it existed six months ago, rather than as it exists now.” (Elizabeth Warren’s report, cited in The New York Times, October 10, 2009)

David Coates holds the Worrell Chair in Anglo-American Studies at Wake Forest University. He is the author of Answering Back: Liberal Responses to Conservative Arguments, New York: Continuum Books, 2010.

He writes here in a personal capacity.

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