The Obama Administration’s $275 billion Homeowner and Affordability Stability Plan is the first real, comprehensive effort by the federal government to address problems in the real estate market. The HOPE Now program supported by the Bush administration has been limited in its effectiveness to address the underlying problems of the mortgage market. The current plan claims that it will help seven to nine million families avoid foreclosure by restructuring and refinancing mortgages. However, this plan not only poses implementation problems, but also creates some perverse incentives for those in danger of delinquency and for those who are current on their mortgage payments.
The thrust of the plan is centered on efforts to refinance mortgages such that rates are lowered and borrowers as well as lenders have incentives to rework mortgages. For borrowers with monthly mortgage payments adding up to 43 percent of monthly income, lenders would have to work with borrowers to lower this rate to 38 percent. Beyond this point, the government would match reductions down to 31 percent. While this may be a noble effort, there are some glaring shortcomings.
There is a primary reason that the government needs to allocate $275 billion to stem foreclosures and repair the mortgage market. Most of the people who are either delinquent or have been foreclosed upon are simply poor credit risks. It is quite possible that payment reductions that result of this plan will not be enough to prevent defaults. Also, once rates are allowed to be reset about five years after the implementation of this plan, borrowers may find themselves in a hole again. There is no reason why a borrower who is in danger of defaulting now will be in a significantly better financial position five years down the road.
The program also offers monetary payments to those who stay current on their loans. What, though, about those homeowners who are not at risk of defaulting and who are current on their payments? Well the government does not see fit to help these homeowners. So, the government is keeping unworthy homeowners in their homes, when the real probability that they will be delinquent has diminished only nominally, if at all. On another note, 40 to 50 percent of Jumbo and alt-A loans, which are reaching subprime levels of default, are not covered by this plan. A better policy may be to simply encourage those currently sitting on the sidelines to enter the market and buy homes. This approach by government could help to restore demand in order to meet supply. While this approach may seem lacking, it avoids the unintended consequences of the Obama proposal and may get at the true cause of the housing market problem.
The Obama administration deserves credit for addressing the housing issue whereas the previous administration was reluctant to do so. Investor confidence not only in the housing market, but in the government’s willingness to take action where necessary, should not be underestimated. However, it is very possible that a lackluster initiative can do more harm that good. The problems in financial markets, while intertwined with the real estate market, must be addressed in a different fashion. To the extent that the current decline in the housing market is the result of imbalances between supply and demand, a more market-oriented solution may be desired.