Mortgage interest rates are at their lowest point in decades (about 4.5%) and the housing credit has been in effect for more than three years, yet the housing market is tepid at best, with foreclosures at record highs and government housing institutions having to put more distressed assets on their books. This has spurred rumors around the web that the Obama administration (via the Treasury) will soon be asking government owned entities Fannie Mae and Freddie Mac to expand their “save the economy” effort by reducing the principal balances for those individuals struggling to pay their mortgage payments. Keep in mind that the President does not need congressional approval for this change because 1) the government already “owns” Fannie and Freddie and 2) the Treasury has removed the previous limits on the amount of money the organizations can tap into (it was $400 Billion, now – no limit).
Unlike most rumors, this one became more, not less, plausible when you examine the details. The White House has made it clear in recent months that it is frustrated by what the Framers called “the legislative branch,” what President Obama calls “politics” and what I call “the wishes of the American people.” Obama craves a short-term sugar rush for the economy. If he feels cornered, betrayed and alone, he could use his new ownership of Fannie Mae and Freddie Mac as a free federal candy store and tell America to line up and pig out. In more ways than one, Barack Obama seems to want to be known as the Sub-Prime President. (source : New York Post)
While this plan may help a handful of borrowers on the edge of foreclosure, there are many more fundamental problems with reducing the principal home loan balances which include:
- The main issue, politically and practically is that it is very unfair to people who have worked hard to stay current on their mortgages. despite being “underwater” on their homes. In fact it is likely to cause a massive revolt by by responsible tax payers and non-home owners, if people who are struggling to pay their home loans and facing foreclosure because of excessive spending/borrowing are bailed out. In essence the government is promoting asset deflation, since it is debasing the value of homes, the largest asset for most people. Imagine if overnight the value of your home is cut by 20 to 30%, thanks to your neighbor’s principal balance reduction.
- Too many people are “underwater” – they owe more than their house is worth. About one in six people are upside-down. Thus the cost of reducing principal balances, which would fall on the shoulders of the banks and GSE’s which would create another financial crisis as firms take massive write down losses and protect their capital more closely (meaning less credit available to small business and consumers). This potential credit crunch would trigger another financial meltdown making the financial crisis of 2007-2008 look like a walk in the park. That’s why lenders are willing to cut interest rates, modify/delay payments, even write off some late fees, but are dead set against forgiving even a dollar of the principal balance (some like BoA have initiated mortgage reduction programs, but with very tight restrictions and little real success)
- If the government allows banks to take tax write-downs for the balance reductions, then tax payers will shoulder the burden of the principal reductions and our national debt will spiral out of control much, much faster. Existing programs like HAMP, to lower payments and modify terms have hardly worked and are subject to so much fraud that it is hard to imagine a principal reduction program being executed any more effectively.
- Unemployment is high and rising, at least in the near term. As the old saying goes, you can’t keep let alone buy a home if you don’t have a job. Even if you have a job, there is a fear you will lose it as companies cut back on spending and hoard capital. Cutting the principal balance does not make repayments go to $0. And if people don’t have any income, then the housing crisis will continue. Insecurity about the future trumps even the best deal in town. So unless Obama and Congress solve the unemployment crisis, cutting home loan principal balances will little or no effect.
It would be very irresponsible of the government to cut principal balances because while it may temporarily help the 10 to 20% of Americans facing or in foreclosure, the remaining 80% of home owners (and tax payers) would pay the long term consequences of this move. Americans feel shame about being irresponsible as shown by many home owners who continue to make payments despite being underwater on their loans. What about the American government?
Disclosure: I am a homeowner who is current on my mortgage!
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