Will Obama’s housing plan provide relief?

THE OBAMA administration claims that its initiative to aid hard-pressed homeowners could help up to 9 million families restructure or refinance mortgages to avoid foreclosure. The plan--valued at $275 billion--is by far the most ambitious to date aimed at the victims of the housing crisis.

But given the scale of the crisis, is it enough?

Certainly, the Obama program marks a break from the Bush administration's do-nothing approach. Its plans have proven woefully inadequate. In some markets, housing values are off 40 percent from their bubble peaks. There were more than 5.3 million foreclosure filings in 2007 and 2008 combined, according to Realtytrac.com.

Compared to the Bush administration's failures, Obama's program looks big. Yet that figure is dwarfed by the estimated $6 trillion in housing wealth that has been destroyed since the peak of the bubble.

And the new plan falls far short of helping all homeowners.

On Wednesday, the Treasury Department published details of the two-pronged program, titled the Homeowner Affordability and Stability Plan.

The first part is a $75 billion program aimed at helping 3 million to 4 million homeowners who are at risk of foreclosure to lower their monthly payments by modifying loan terms.

The second part, open only to homeowners whose mortgages are owned or financed by Fannie Mae and Freddie Mac--the giant mortgage lenders bailed out by the federal government last year--is meant to refinance the loans of 4 million to 5 million Americans who owe more than their homes are worth.

Under part one, in order to help lower monthly mortgage payments, the government would pay mortgage-servicing companies an upfront fee of $1,000 for each eligible modification, plus "pay for success" fees of up to $1,000 each year for three years if the borrower stays current on the loan.

The plan also includes incentives for mortgage servicers and mortgage holders to modify loans of borrowers at risk of falling behind on payments. Borrowers, meanwhile, can receive a reduction on the principal amount of the loans they owe--$1,000 a year for five years--if they stay current on their modified loan.

Lenders can begin modifying troubled loans under the program immediately. To be eligible for modification, the loans must have originated on or before January 1 of this year. The program will end in December 2012, and loans can be modified only once under this part of the program.

The second phase of the plan loosens lending rules for Fannie Mae and Freddie Mac in order to help more borrowers refinance their homes.

Importantly, Fannie Mae and Freddie Mac will have the power--for the first time--to refinance mortgages that exceed the value of homes. That way, people who are "underwater" on their mortgages--that is, who owe more than the reduced value of their homes--will be able to get a new mortgage on better terms. However, they will be able to get loans only up to 105 percent of the house's value--which means that people whose home price has fallen drastically will still lose money.

According to estimates, approximately 20 percent of the 50 million mortgage holders in the U.S. owe more than 105 percent of their home's value. While many of these people are wealthy individuals who bought pricey homes, many modest-income homeowners will also lose out if they bought houses in places like Las Vegas or suburbs in California, where home values have dropped sharply.

"The refinance portion of the plan is set up so it provides the least help for the people who need it most," Christopher Mayer, a professor of real estate at the Columbia Business School, told the New York Times. "We're missing an opportunity to help many more Americans."

ANOTHER KEY to the Obama administration plan are provisions that will allow Fannie Mae and Freddie Mac to hold up to $900 billion in mortgages and mortgage-backed securities until next year, which will enable them to buy new and refinanced mortgages from banks and other mortgage lenders.

In addition, the plan eases rules that bar the companies from owning or guaranteeing mortgages that are more than 80 percent of a home's value. Those with less than 20 percent equity will be able to refinance their mortgages until June 2010.

The plan also includes the introduction of a formula for calculating monthly payments. Under past programs, when owners fell behind, the missed payments simply got tacked on to the principal. That method doesn't reduce monthly payments--and as a result, as many as half of borrowers put in these plans ended up defaulting on their mortgages again.

By contrast, the new program restructures loans so that home payments will account for no more than 31 percent of a borrower's monthly income. Under this plan, all debt payments--including car loans and credit cards--must be no more than 55 percent of pre-tax income. Lenders can drop interest rates to as little as 2 percent to achieve the ratio, and, if necessary, extend the term of the loan to as long as 40 years.

This restructuring could provide a lifeline for homeowners drowning in debt. However, Obama has so far refrained from pushing a measure that would provide far greater relief--giving bankruptcy judges the authority to "cram down," or reduce, mortgage loan balances on primary residences of people who file for bankruptcy.

If bankruptcy judges were granted this authority, it could mean, for example, that a borrower wouldn't necessarily be faced with paying back $300,000 on a home now worth $200,000. Bankruptcy judges would be able to reduce or eliminate much of that debt--something they already have the power to do on mortgages on secondary and vacation homes.

While leaving people's fate in judges' hands is always a dicey proposition, the possibility of cram-downs would be of great benefit to borrowers who are underwater--who owe more on the mortgage than their home is currently worth. Latest estimates put that number at 13.6 million households.

Banking trade groups, including the Mortgage Bankers Association--which played no small role in helping inflate the housing bubble through cheery forecasts--have lobbied for years to keep cram downs from being allowed on primary residences.

Congress is set to address the issue in the coming days. Under compromise legislation brokered between liberal and conservative Democrats in the House of Representatives, judges would get the authority to "cram down" the principal on mortgages--but only after borrowers go through a lengthy and complex process to renegotiate the terms of the loan with lenders.

Even if the Obama housing plan meets its objectives, millions of homeowners will be left out. According to Zillow.com, only 25 percent of homeowners have home values high enough to support refinancing under the new plan. Furthermore, borrowers who took out jumbo loans--the old limit was $417,000--as well as owners with sub-prime loans that Fannie and Freddie didn't insure, aren't eligible for the program.

Moreover, Obama's plan doesn't help people who have already lost their homes. Nor does it address the problem of modifying loans that have been sliced and diced into giant securities, and sold off to big investors. Because it's unclear who ultimately owns these loans, mortgages fed into Wall Street's "securitization" machine have been more likely to end up in foreclosure than loans held on bank balance sheets.

The plan also is incredibly timid in reducing the principal owed on loans--figures which reflect home prices at the height of the bubble. The incentives to renegotiate are based on keeping payments current by lowering interest rates. That could lead to mortgage holders having lower monthly payments, but not change how much they ultimately have to pay off.

EVER SINCE the housing bubble began to collapse, right-wing, pro-business voices have lurched wildly from claim to claim in attempts to pin the blame for the crisis on victimized homeowners.

In the latest bout of nonsense, CNBC blowhard Rick Santelli raved from a Chicago trading floor about the government promoting "bad behavior" and subsidizing the "losers' mortgages."

The truth is that millions of homeowners were victims of a system that encouraged fraud. Wall Street created a voracious demand for mortgages that it could securitize--that is, turn into bonds that could be sold to giant investors. As this market grew, mortgage brokers were paid for volume, not to vet mortgages, and a series of predatory practices emerged.

Countrywide Financial--once the largest mortgage lender in the country--was at the forefront of this game. It commissioned mortgage brokers to steer borrowers into dangerous sub-prime mortgages--housing loans made at higher-than-normal and adjustable interest rates to people with little or poor credit history or an income that wouldn't typically qualify them for a mortgage.

Such loans came with interest rates that were 2 to 5 percent higher than prime loans. But that fact was hidden by two or three years of lower "teaser" rates, during which payments typically covered just the interest, if that--certainly not the loan itself.

All together, sub-prime loans added up to $2.5 trillion worth of mortgages since 2000. For helping spread the use of these dangerous loans, Countrywide offered brokers--the agents who actually sold them to borrowers--higher commissions.

Mortgage brokers--who are involved in about 60 percent of all mortgage loans--had a huge incentive to push borrowers into riskier deals. They received higher commissions, called yield spread premiums, on sub-prime loans compared to conventional mortgages--on average, brokers were paid 1.88 percent of the value of sub-prime loans, compared to 1.48 percent of conventional mortgages.

To get borrowers into sub-prime mortgages, brokers often fudged paperwork--inflating income and assets for borrowers who normally wouldn't qualify for any kind of mortgage, while encouraging other borrowers who qualified for prime loans to hide assets and lower their stated incomes to get sub-prime loans.

As the world now knows, these practices were a time bomb that has now blown up the world economy. Obama's housing plan, finally, provides some relief to some of the victims. But it is far from enough.