Obama’s Christmas in August? Really?

James Pethokoukis writes on Reuters today (h/t: Instapundit) that the Obama Administration may be planning to eliminate many/most/all underwater mortgages in a single swoop:

Rumors are running wild from Washington to Wall Street that the Obama administration is about to order government-controlled lenders Fannie Mae and Freddie Mac to forgive a portion of the mortgage debt of millions of Americans who owe more than what their homes are worth. An estimated 15 million U.S. mortgages – one in five – are underwater with negative equity of some $800 billion. (Emphasis mine)

If this does come to pass, the mind simply boggles at the thought.

The underwater mortgages would become Federal government debt practically overnight.  It might be time to think about not paying your mortgage….

How Would This Even Work?

Presumably, the way it would work is for Fannie & Freddie to do a one-time reset of all of the mortgages in their portfolios to some sort of “appraised value” based on homeowner request, which would include some sort of appraisal conducted at the homeowner’s request.  If Fannie/Freddie then approves the “reset”, there would be some sort of a purchase of the full mortgage contract from the bank who “owns” the mortgage, then a write-down by Fannie/Freddie of the value.  The Fed would supply Fannie/Freddie with the money to stay solvent while taking these massive write-downs.

So let’s say you’ve got a $500K mortgage on a house whose value has dropped to $350K.  The bank who wrote the mortgage may have packaged it into some MBS with various streams of payments due the bondholders.  You now make an application to have your mortgage reduced; you get an appraiser to come in, look at the house, and issue an appraisal of $350K.  If approved, then presumably, Fannie would reduce the stream of payments it was due from the bank to the $350K principal level, and write down the resulting loss on its books.

Then again, if there are multiple different bondholders… Fannie might have to pay those people off to buy their payment streams in discounted present value basis.

Maybe if the loan is still on the bank’s books, Fannie would simply purchase it for the face amount, then take the loss directly, and send it to whichever servicing company Fannie uses to handle collections and payment processing.

The whole thing would take some time, I think, but all underwater mortgages would become “overwater” mortgages overnight.  At the cost of some $800 billion, of course.

Plus, there are a host of unanswered questions — which is inevitable given that we’re talking about a rumor here.  But I wonder….  If after a homeowner receives this “mortgage reset”, house prices rise, and he ends up selling for a profit… would he have to pay that back to the Fed, or is that his to keep?  Would only primary houses be eligible, or investment property as well?  Would the loan have to be delinquent to be considered, or would there be relief for homeowners who have kept current, despite being underwater?  Would second or third mortgages or even refis be eligible, or only the primary mortgage?

Argh, so many questions without answers….

Is This Good or Bad for Real Estate?

Many taxpayers would be understandably irate if such a thing were to come to pass.  As Pethokoukis notes:

The political calculation is that the number of grateful Americans would be greater than those offended that they — and their children and their grandchildren — would be paying for someone else’s mortgage woes.

But leave the political realities for other blogs to cover in greater depth.  What about for the real estate industry?  Would such a “loan forgiveness” program be good or bad for real estate?

Presumably, short sales would disappear, since no house would actually be underwater anymore. Foreclosures are likely to come to a halt or a near-halt; why foreclose, when you the bank might recover the full value of the mortgage from the Feds?  Would prices recover?  Since the principal reduction would have to go hand-in-hand with a new appraised value of some sort, if anything, wouldn’t that create a “new normal” for the pricing for housing in a given area?

Would banks relax their lending standards, knowing that Fed would bail them out if the loan goes underwater?  Even if this “reset” is sold as a once-in-a-lifetime thing, wouldn’t bankers be justified in believing that a precedent has been set?  Units might go up if true, but that almost suggests that we’ll have another bubble in real estate in a few year’s time, no?  Or have things changed sufficiently now?

Boy… I really haven’t a clue as to whether this sort of a bailout-for-homeowners would be a good thing or a bad thing.

As Pethkoukis says, August 17th is a key date, as that is when the Treasury will hold a hearing on the future of Fannie and Freddie.  Keep an eye on Washington; these be interesting times we live in.

Your thoughts on either the mechanics of how such a thing might work, or the desirability/undesirability of the “bailout”?


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Rob Hahn

Managing Partner of 7DS Associates, and the grand poobah of this here blog. Once called "a revolutionary in a really nice suit", people often wonder what I do for a living because I have the temerity to not talk about my clients and my work for clients. Suffice to say that I do strategy work for some of the largest organizations and companies in real estate, as well as some of the smallest startups and agent teams, but usually only on projects that interest me with big implications for reforming this wonderful, crazy, lovable yet frustrating real estate industry of ours.

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19 thoughts on “Obama’s Christmas in August? Really?”

  1. Moral hazard at play here. Seems like the only way to limit the risk of banks moving back to offering extremely risky loans would be to package in some federal restrictions on lending related to the creditworthiness of borrowers.

  2. Well, as I said, this is a RUMOR, not news, that Pethokoukis was writing about. And I respect the folks at CR a whole lot. Having said that, it isn't as if CR is Obama or Geithner or Bernanke. And CR's post was simply an opinion as far as I can tell.

    So rumor vs. opinion. I'll wait for official word from someone in the Administration either confirming or denying the rumor… or see what the 8/17 meetings result in, if anything at all.


  3. Given the tendency this administration has to print money it's not a hard rumor to believe. If this does turn out to be true then it would be the most direct and open move to buy votes this world has ever seen. Blago's got nothing on Obama … of course, now we can all see where he learned it from! 😀

  4. The sad thing is that many homeowners could have been able to make that mortgage payment, when one of the two Mr. or Mrs. lost a job. This is the case here in MI. But, banks would not modify so they had to sell short or go into foreclosure. It was sad to see and hear so many homeowners upset that their homes were sold for what they could have afforded to keep if the banks had modified.

    This is not really a political post but I will say, the current administration has to come up with something to put a smile on voters faces, looking at his numbers declining everyday.

    Interesting to think of since the new FHA guidelines will be bringing in 3.6 billion annually to boost their reserves.

  5. Would such a “loan forgiveness” program be good or bad for real estate?

    If you define “good for real estate” as an end to the decline in home values…well then, yes, it would be good. If you cease to have new, lower (short sale/foreclosed) comps on the MLS or in public records, then you stop having the vicious cycle we see now. You stop having homeowners just walk away and leave a home vacant for 2 or more years. The adjusted values would not be a public record akin to what an appraiser would use or have access to…just like a loan mod.

    If it is done on ALL property…investment, etc, then we'd have a windfall for the IRS…forgiven debt is considered income (if it is not a primary residence)…so I could see the Administration saying “It will cost us $800B, but we'll recoup 1/4 of that in a years time in additional tax revenues”.

    The actual key would be a new mortgage set up as an “equity sharing” mortgage…with a declining liability, possibly expiring if the current owner stays in their home 15 years. THEN, the spin would be that the $800b would be FURTHER reduced with the equity growth created by this very proposal.

    All (actually some) cynicism aside…it just may work. It may help the economy and will most certainly help Obama and the Dems in the upcoming midterms…an $800b vote buying, taxpayer funded initiative.

  6. One more thing to think about…remember last Christmas…weren't the loss limits for Fannie and Freddie eliminated? Is this what they had in mind way back then?

    “In an oddly timed move, on Christmas Eve The Treasury announced what essentially amounts to a blank check for the potential bad debt of Fannie Mae and Freddie Mac. Prior, the Treasury had a $200 Billion (each) limit on bailing out the “insolvent” mortgage lenders.”

  7. I am glad this seems to have been dispelled as a rumor because I think it would have had a disastrous effect on the housing market and the political implications were not pretty. It sounded like an attempt to buy votes IMHO and not a solution to the problem of underwater mortgages.

  8. Are we in Cuba or Venezuela? Man, Uncle O just doesn't give up on his quest to make us a socialist state.

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