Monday, October 31, 2011

Learning to Play the HARP

A week ago the Obama Administration announced revisions to the Home Affordable Refinance Program (HARP).
Better late than never! Actually, coming three years belatedly, a change to HARP may bring some relief to homeowners and the economy.
But is it a viable solution?
As you may know, I have written extensively about the failure of both the Home Affordable Modification Program (HAMP) and HARP.
Is the new and improved version of the two-year old HARP a quick fix or yet another boondoggle in the making?
Real Estate and Jobs
Last week's announcement stems from the revisions developed by the Federal Housing Finance Agency (FHFA), the GSE's overseer, with feedback from lenders, mortgage insurers and other mortgage industry participants. In a sense the revisions are a patent admission that the economy simply will not regain its strength without a robust real estate market; or, put another way, jobs will not return unless a strengthened real estate market returns.
The linkage of real estate to jobs has roots in the MBS World, a murky realm way below the revisions contemplated by the Administration and the homeowners' needs.
The Federal Reserve has a central place in the MBS World, since it is permitted to participate in the agency MBS financial instruments, and not permitted to participate in buying equity, real estate, or corporate debt.
Remember: MBS yields are the primary trigger in the formation of mortgage rates. The safest financial instruments, of course, are Treasuries; so, relative to Treasuries, the margin or spread between mortgage rates and yields on 10-year Treasuries has continued to move upward. When the Fed makes its MBS purchase, it thereby reduces mortgage interest rates, compressing those relative margins. Operationally speaking, then, a so-called target for mortgage rates is set in this manner.
Ostensibly, lower mortgage rates lead to refinances and the concomitant diminution of financial pressure on homeowners who have been trapped in the housing crisis with underwater mortgages, because such reduction both lowers the cost of debt service through refinance and supports purchases of houses, which creates demand - and thus an increase in pricing - for housing.
What Went Wrong?
To date, a tiny percentage of seemingly eligible borrowers have refinanced through HARP.
In my estimation, these are the factors that led to the HARP failure:
-Resistance: the refusal by some second lienholders to subordinate themselves to the first mortgagee.
-Fear: the GSEs might "put back" the new loans if they subsequently move into default, which causes constrained underwriting.
-Restrictions: the original MI being applied to the new loan, particularly if the new loan has a different servicer.
-Reluctance: homeowners afraid of being rejected, lack of public awareness, and insufficient news about program information.
Also, it is common knowledge that lenders have rejected all but the most creditworthy borrowers from taking advantage of HARP, out of reluctance to take on the risk of existing representations and warranties; however, this may yet find a solution (see below).
Plans and Suggestions
In this latest version of HARP, there is an extension of the program's mandates through December 2013. As a quick overview, I think it's fair to describe HARP as a temporary program by the GSEs, the primary goal of which is to permit borrowers whose loans are currently guaranteed by the GSEs to be refinanced, despite the fact that these loans are significantly higher than 80LTV.
There are some important revisions, perhaps the most important being the removal of the 125LTV ceiling. In addition, in many cases a new appraisal is eliminated, fees to borrowers are lowered, and the GSEs are waiving some lender representations and warranties (about which we will know more by November 15, 2011, when the program guidelines are issued).
I think the revisions to representations and warranties are needed and justified, inasmuch as all loans eligible under HARP have been seasoned for more than three years, and defects in a loan usually show up in the first few years of the loan. So, the risk - and the implications for representations and warranties - is certainly much lower at this point.
As to homeowners' reluctance and lack of information, although the HARP revision does not require it, I think the GSEs should communicate with potentially eligible borrowers and let them know that their loans are eligible under HARP at current mortgage rates.
With respect to the resistance of second lienholders, many studies suggest that second liens are no longer a major barrier to refinancing. It is very important that second lienholders participate in the program, because refinancing the first lien ameliorates the condition of the second lien, due to the fact that it frees up funds that can be used for second lien servicing.
The MI issue is a thorny one. The fact is, notwithstanding the foregoing, borrowers with MI will have fewer options than others to refinance. It remains to be seen how the proposal to waive aspects of the representations and warranties will incentivize servicers to resolve the MI debacle.
A Macroeconomic Solution
So, can revamping HARP bring new jobs and stabilize the real estate market?
One study I have read, a CBO research paper, estimates that a revised HARP, structured along the lines I've outlined above, would (1) result in $428 billion additional refinancings with annual savings to households of $7.4 billion, (2) would have a small positive effect on the GSEs' net worth, and (3) would have a small net cost to the government of less than $1 billion (which, in any event, is subsumed by the Fed's prepaid MBS portfolio).
The overall effect is to create a stimulus, since HARP beneficiaries will have higher marginal means to create demand, that is, their consumption will more than offset the opposing demand from existing MBS investors (i.e., financial institutions). Based on the studies I have read, if HARP increased GDP by as little as $1 billion per year for two or three years, the additional tax revenues would significantly exceed the costs. So, the macroeconomic effect would be net positive and stimulative.
Finally, if mortgage rates were sustained by the 2% to 2.5% range that has been a trending indicator, when combined with the HARP revisions, there would be a very substantial boost of mortgage loan originations, perhaps enough of a boost to a sizeable part of the GSE portfolio. Such an impetus would mean a re-set of trillions of dollars in asset value, and a yearly reduction in household interest expenses into the many billions.
The Fed's Role
As I see it, the Fed can weigh in forcefully in supporting the HARP revisions.
For instance, if the Fed purchased as much as $2 trillion of new MBS, then existing MBS holders would be displaced into investing that $2 trillion elsewhere. Hence, such re-investment would lead to an increase in stock prices, reduction in debenture yields, increase in real estate values, and higher foreign currency values.
A recent study, conducted by the San Francisco Fed, clearly shows that Fed purchases upward of 2$ trillion would increase GDP by more than 2% in two years and create 3 million new jobs. If the HARP refinance revisions are factored in, the overall stimulative effect would be much larger, perhaps as high as creating 4 million new jobs.
Moving forward robustly with the HARP revisions would surely lead us to conclude that the new and improved version, though coming about belatedly, is not too little, too late.
What do you think?
Please feel free to comment!