Thursday, 27 October 2011
Restringing the Housing HARP
Such transfers have been the norm since the Federal Reserve instituted its zero-interest-rate policy in late 2008—shifting funds away from the likes of depositors, bondholders and pension funds to debtors. The latest iteration came Monday, when the Federal Housing Finance Agency unveiled changes to a program meant to make it easier for underwater homeowners who are current on payments to refinance into a lower-rate mortgage.
The thinking is that this will reduce defaults. Or as FHFA said, "Such refinances bring benefits to borrowers, to housing markets, and taxpayers."
Missing from that winners' list:
investors who finance housing markets by purchasing mortgage-backed bonds. They will fund this new effort. Here is how: As homeowners refinance, investors who bought mortgage bonds will be given back their money and will have little option but to reinvest at far lower yields. The transfer is the difference in yield.
Just how big that will be isn't clear as it is tough to tell how effective the program will be. The original Home Affordable Refinance Program, or HARP, led to refinancings by 894,000 homeowners in about two years. Estimates for how many borrowers could now take part range from 500,000 to three million, while FHFA said it is "very difficult to project the number of mortgages that may be refinanced." Some mortgage bonds traded lower Monday on news of the plan.
Granted, prepayment risk is inherent to mortgage bonds. There is also likely to be little sympathy for bondholders having to give up money to shore up housing. But that ignores that the government is picking winners and losers. Effectively, it is deciding some losses on some things are acceptable, say on 401(k) retirement plans, yet aren't on others, namely housing.
The government also potentially undermines its own effort to create a housing-finance market independent of Fannie and Freddie. Many mortgage investors may choose to reinvest elsewhere, ultimately shrinking the pool of lenders available to fund that market. In the short term, the Fed may well take their place. That isn't the basis, though, for a functioning mortgage market underpinned by private capital.
Another unsettling wrinkle: The FHFA is adding an incentive for borrowers to refinance into shorter-maturity mortgages. But in many cases, this will mean a borrower's monthly payment, including principal repayment, won't decline. It may actually rise. That undermines the notion that these borrowers are unable to meet monthly payments and need government assistance.
Banks may also benefit depending on how FHFA decides to limit the risk that they could be forced under some circumstances to repurchase shoddily underwritten mortgages.
The biggest issue, though, isn't necessarily with HARP or similar programs. It is that both parties in Washington are studiously avoiding any real effort to overhaul housing finance and decide what to do about Fannie and Freddie.
