Analyzing Obama's Foreclosure Prevention Plan

The fact sheet on the foreclosure prevention plan released by the Obama Administration is at http://www.treas.gov/initiatives/eesa/homeowner-affordability-plan/FactSheet.pdf. In this post I'm providing an analysis of this plan but will stick to the ones that are in sufficient detail.

The first proposal of providing low cost refinancing to responsible borrowers is to appease everyone who's probably going to be upset with the rest of the plan and I'll get to this in a minute. It is interesting however that this non-problem area is the first thing that's addressed in the plan. The “I come in peace – wink wink” approach.

The second proposal is the real meat and so let's dissect this. This is basically very much like a 401K plan where an employer matches up to a given percentage of the employee's contribution. If the bank is willing to reduce the mortgage down to 38% of the borrower's income (net or gross is not specified), then the government will pitch in and match dollar-to-dollar a further reduction down to 31%. Seems like everyone's got skin in the game.

Let's do some numbers based on the median income of about $45,000. Let's also say this was the kind of borrower who bought too much house, say 10% more than the 38% mark that the bank is now required to bring it down to. That would make it 48% of his income and a loan payment of $1,800 a month. This is equivalent to a loan amount of 250K. For the banks to bring this down to 38% that would mean a payment of $1,425 a month or a loan amount equivalent to 200K. So the bank has to take a 50K loss before they qualify to play the match game. This game would cost the bank an additional 20K and the government 20K. The total loss for the bank is 70K netting the bank 180K. Assuming this borrower had put 10% down then this house was worth $275K when the loan was made. Assuming the bank can get 65% in a foreclosure auction that would have net the bank about 180K. So that's a wash.

About the incentives to servicers: There seems to be an attempt to make them do the right thing by giving them more rewards if the borrower stays current but given the $1000 fee for just doing the initial rewriting, most servicers are going to consider the rest gravy and simply try to pile people on to the rewriting wagon. We all know how aggressive servicers can get. The up to $5000 incentive to borrowers is something that should upset the tax payer. Is bailing them out not good enough an incentive to these borrowers?

Now, let’s talk about the ‘refinance for all’ proposal. In short this will allow people to waive the 80% LTV requirement for refinances and benefit from the low interest rates. Let's do some math again with the median income albeit responsible borrower this time. She would have purchased a 200K home with 20% down and a mortgage of 160K. If her property has depreciated 10% since she bought it now she can get a loan for 180K lowering her skin in the game by 50%. Wasn’t over-leveraging the systemic problem to begin with? We have taken a responsible borrower and made her a potential bailout risk.

Finally about investing $400 billion in Fannie and Freddie: Do the MBS investors really care if the reason their returns are down is due to the foreclosures not generating cash flow or due to these newly negotiated lower payments? Each of these mortgages is structured such that out of the payment made by borrowers, the investors get steady returns. If those payments are going down, so must the returns. So not sure, if lowering the attractiveness of MBSs to the investors and sinking an additional $400 billion into the same vehicle in the same proposal is a wise thing to do.