U.S. Democrats Promote Massive New Federal Housing Authority Program to Assist the Distressed Mortgage and Housing Industries

• Mortgage lenders who are dealing with homeowners with little or no equity would accept payment of up to 85% of current appraised value—implying sizable cumulative write-downs of 20–50%, depending on the particular market location.
• Mortgage servicers would find an FHA-approved lender, who would step in and issue a new mortgage and pay off the written-down balance of the old mortgage loan
• The FHA would underwrite mortgage insurance with a new mortgage insurance pool to be funded by Congress that would back up roughly $300–400 billion of additional lending.
• New loan must be within the newly applicable FHA limits, and only owner-occupied housing would be eligible, and borrower must be reasonably able to pay the new terms.
• Affordability could be achievable in many cases, as the required write-downs would lead to lower principal payments and subsidized FHA insurance would reduce the mortgage interest rate.
• New mortgage loans could be securitized through Ginnie Mae (GNMA)
• The cost of the new FHA insurance pool is estimated at $20-30 billion—the Congressional Budget Office has been asked to provide an estimate.
• The federal government retains a second lien on the property, and if the homeowner sells the property, he/she would pay a fee, which would be the maximum of 3% of the original FHA loan balance, or 100% of the capital gains in year one after refinancing, declining to 20% in year five and zero thereafter.

Analysis

The proposal by Frank and Dodd is gaining momentum in Congress. A bill along these lines is certain to be crafted in the near future. Just how much bipartisan support might be garnered for a bill along these lines is difficult to ascertain. Congress is becoming increasingly concerned about the ongoing crisis in the housing market, and is terrified about the prospect of going into the fall elections without another major program in the pipeline. Therefore, it is quite likely that enough Republican support could be mustered to move a bill through the House and the Senate. The tough sledding could potentially come from the Bush administration, which has not warmed up to the Frank-Dodd proposal.

The funding provided by Congress for the mortgage insurance pool would be more than likely treated as a credit subsidy to be paid out over perhaps two years. This would push up federal expenditures, the federal deficit, and overall federal funding requirements. That being said, Treasury interest rates are extremely low, and with the severe risk aversion that has plagued the financial markets over the past three months, we would not expect to see much, if any, upward pressure on Treasury interest rates.

The Frank-Dodd proposal would be primarily aimed at the subprime mortgage market. It would have the greatest success in those areas of the market that might be discounted by perhaps 25–35%, or about a 10–15% discount below the estimated write downs of 15–20% that have been already taken. However, the deeply discounted areas of subprime may still be problematic, given the additional write downs of perhaps 20–30% that would be implied. This area of the subprime market may end up stranded until the overall housing market shows clear signs of revival.

The Frank-Dodd program, in conjunction with the new lending authority conferred on Fannie Mae and Freddie Mac, and the green light given to the Federal Home Loan Banks to buy an additional $160 billion in mortgage-backed securities, is starting to add up to serious new resources being committed to the housing market. Depending on how much additional capital Fannie and Freddie can raise in the markets, their new lending authority amounts to $500–700 billion in additional mortgage funds coming to the market. If you add in the new Federal Home Loan Bank lending capacity and Frank-Dodd replacement programs, then we would be approaching roughly $1.0–1.2 trillion in additional funding flowing into the mortgage markets. Granted, a sizeable chunk of this new funding will be directed to refinancing, Frank-Dodd replacement funding, and purchases of severely price-discounted securitized debt.

The Frank-Dodd program does have some merits. It would allow lenders to get out of distressed mortgage payment situations, if they are prepared to take the large write-downs implied. For many subprime lenders who have already taken major write downs, the additional write-downs under the program may not be so difficult a pill to swallow, if they want to move on and out of this type of lending and clear their books.

On the other hand, the FHA is limiting its risk by committing to a new mortgage only at a maximum of 85% of the currently appraised value. It could be a win-win situation if it catalyses a trough in the housing market over the next few months, and contributes to unwinding the gridlock that seems to have enveloped the credit markets in general.