HARP 2.0 – Old Wine In New Bottles

In my earlier post I was critical of the Obama Administration’s second run at jumpstarting the woefully inadequate Home Affordable Refinance Program or “HARP.”  As pointed out in my post, HARP had been an abysmal failure since its inception in 2009.  Then, on September 8, 2011, in the course of rolling out the American Jobs Act [which appears dead in both the House and Senate – PCQ] the President stated:

“And to help responsible homeowners, we’re going to work with federal housing agencies to help more people refinance their mortgages at interest rates that are now near 4%.  That’s a step – (applause) – I know you guys must be for this, because that’s a step that can put more than $2,000 a year in a family’s pocket, and give a lift to an economy still burdened by the drop in housing prices.”

At the time, there was not much to go on, since like so many of the Administration’s pronouncements, they are little more than trial balloons that get floated, and finally run out of the hot air. So, where are we now, seven weeks later?  Well, the folks that brought us HARP I are slowly giving birth to HARP II.  But as of the date of this post, we’re still waiting on specifics.

There appear to be certain similarities and certain differences. First the similarities:

  • It is a voluntary program, meaning that the banks will not be “required” to participate;
  • It is limited to loans owned by the two GSEs, Fannie and Freddie;
  • The borrower must be current on the loan sought to be refinanced.

My reaction is that with any voluntary program there is no real financial incentive for banks to participate.  If the goal – as it was in the 2009 program – is to help homeowners refinance despite having negative equity, why are banks going to want to jump into that briar patch?  In theory, the answer is that since these loans were already guaranteed by the federal government (aka “the taxpayer”) trading one bad loan for another will effectively change nothing.

But that isn’t entirely correct.  According to the Financial Times, HARP I was supposedly responsible for approximately  822,000 refinancings of loans with under 105% LTV; but only 68,000 were over 105% LTV.  How much over 105% is unknown, but under HARP I the maximum negative equity was 125%. HARP II places no cap on the maximum LTV.  However, since home prices have continued to fall over the last two years, this would suggest that banks would be biting off even larger chucks of risk that would be subsidized by the American taxpayer.  Given the meager 68,000 refinancings over 105% LTV of HARP I, I have to wonder how many people – and banks – will have the appetite to participate in HARP II.

My second observation is that during the financial and foreclosure crisis of the last few years, the GSEs did not control the secondary mortgage market.  In fact, the “private label” secondary market dominated.  This was because the private label market bought non-conforming loans – the ones that didn’t qualify for Fannie and Freddie.  As we know, this is where the loose lending practices flourished, and unheard of mortgage products such as “stated income” loans, “no-doc” loans, “neg-am” loans, “pick a payment” loans and Option-ARMS, became popular.  They also became toxic, and many have since disappeared.

My point here is that these folks – those who got into the high-risk loans – are still being hurt, assuming they continue to own their home.  If they are current on these loans today, why should they not be helped?  They are suffering as much, if not more, than borrowers of the conforming GSE loans.  And they are in much larger numbers.

Unfortunately, the answer is pretty clear:  The private label secondary market consists of loans that got securitized and sold to investors all over the world.  But, these investors have no real guarantees from the sellers of the loans, since they’re not backed by Fannie or Freddie.  While the Federal  Housing Finance Agency (“FHFA”), the GSEs’ overseer, can create HARP for Fannie and Freddie loans, there is really nothing short of congressional legislation that can be enacted “forcing” banks to participate in refinancing private label loans.  And gridlock prevents Congress from passing the legislation necessary to expand HARP II to this segment of borrowers.  In order  to find out if your current loan is owned by Fannie go this look-up link, and go to this look-up link for Freddie.

Thus, subject to the changes discussed below, HARP II contains several of the same impediments as HARP I.  Even with its reach expanded by removing the 125% LTV cap, it is unlikely that borrowers are going to participate in large numbers.  I hope I’m wrong.  But if a husband and wife sit down at the table with a sharp pencil, they will see that refinancing a home with say, $75,000 negative equity, makes no real sense.  As pointed out by one commentator:   “The FHFA itself, in its press release, helpfully points out that for someone with a loan worth 25% more than their house, they won’t start building equity in their home for ten years if they refinance into a 30-year fixed-rate mortgage.”

Ten years!  Who has that kind of time to dig out the financial morass known as “negative equity”?  That means ten years of accumulating zero equity to apply toward purchase of another home.  Most homeowners today are kicking themselves for even getting caught up in the real estate frenzy that encouraged them to bite off more than they could chew.  Why would they now refinance that upside down loan, ostensibly saving a couple hundred dollars a month, for the right to wait a decade or more to see any equity?  And if they want to shorten that up, they will have to refinance into a faster amortizing loan, such as a 15 year term.  But if they do that, there will likely be larger payments, and thus, no real monthly savings at all.

Although the White House argues that any extra money will find its way into the economy, in the form of consumer purchases, I think we’re seeing a more chastened consumer today.  Perhaps poorer, but certainly wiser.  Refinancing thousands of dollars of negative equity to save a couple hundred dollars a month is not a bargain that I believe most homeowners will jump at.  While HARP may help folks on the cusp of negative equity, e.g. 105% or so, those more significantly underwater will quickly realize that HARP II is really an exercise in futility.

The Administration has sweetened the deal for lenders who participate in HARP II.  Normally, when a lender sells a loan to Fannie or Freddie, the transactional documents include representations and warranties, (aka “reps and warrants”) about the quality of the due diligence and underwriting that occurred prior to making that loan.  Under HARP II, the GSEs will not require reps and warrants from the lenders who sell them newly refinanced loans.

Will this be a big inducement for banks to lend on homes with huge negative equity?  Well, consider this: Since the new borrowers seeking to refinance must be current, and HARP II only applies to loans sold to Fannie and Freddie before May 31, 2009, most refinancings will be loans that have already been seasoned for three to six years.[1] In short, they are already “low risk” borrowers.  The GSEs’ need to rely on reps and warrants for these borrowers is already minimal.  Conversely, the banks are being let off the hook on requirements they could easily make anyway.  So I question whether this waiver of reps and warrants will really amount to much of an inducement at all.  Maybe there’s something else that will incentivize lenders to refinance homes that are significantly underwater, but so far, I haven’t seen it.

One of the biggest impediments to HARP I, in my opinion, was how it dealt with subordinate liens, i.e. those second mortgage lenders who were behind the first lender in priority.  Under HARP I, a refinance of the first loan could not occur unless the second lender agreed to remain in a second position while the same or another lender made the new loan.[2] Keep in mind that most second lenders who made loans between 2005 and 2008, have little or no equity to attach to today.

For example, assume that a borrower in 2005 obtained an 80% first loan and 20% second loan on a home originally appraised at $300,000. Assume a 30% loss of value between 2005 and today.  This means that the principal balance of the first loan of approximately $240,000 [I’m disregarding the nominal principal reduction. – PCQ] is now secured by a home valued at $210,000. It also means that although the first lender has some risk due to the fact that their principal loan balance exceeds the home’s value, the second lender’s $60,000 loan is secured by nothing – in other words it is now totally “unsecured.”  In the event of a foreclosure, the auction sale would not yield any funds for the second lender.  This would be the same result if the borrower sought to short sell the home today.

Since HARP II, like HARP I is entirely voluntary, what possible incentive is there for the second lender to agree to remain in the subordinated and unprotected position, while the first refinances?  Here’s the government’s pitch:

  • HARP II will allow borrowers to obtain lower rate loans and;
  • Either (a) afford shorter term loans thereby amortizing their debt faster, or (b) reduce their monthly loan payments, leaving extra money to use for other essentials;
  • Ergo, the subordinated second position lender, while still exposed to risk, will be exposed for a shorter period of time or a borrower with more disposable income to pay down the debt on the second loan.

Reportedly, the Big Banks have agreed to retain their subordinated positions to HARP II loans.  I’ll believe it when I see it.  I think it may be likely that if the first and second are held by the same bank, there will be cooperation.  I would not expect that to happen if the second loan was held by a different bank.

But riddle me this Batman: How dumb do the government HARPists think borrowers are?  If one’s home has, say, $100,000 in negative equity, it will be years before they can dig out.  Yet if they default on the loan and it is foreclosed, ORS 86.770 says the bank cannot pursue them for the deficiency [i.e. the difference between what the bank receives on foreclosure and the remaining debt due under the promissory note. – PCQ).[3] And perhaps the biggest downside to a HARP II loan today is that if the borrower struggles valiantly to remain current, but defaults in 2012, there is a distinct possibility that a foreclosure that is not finalized until 2013 could result in significant taxable income to that borrower.[4]

Lastly, I believe that the entire premise of HARP I and II is flawed by incredible short sightedness.  Here’s why:

  • Many people want to move, but cannot because of their negative equity, which gives them a choice between two evils – either short sell now and relocate with no equity to transfer to another home, or stick it out for another decade or more in order to see some equity.  Refinancing will do nothing to allow borrowers to move to new locations for employment or other lifestyle reasons.
  • Since refinancing does nothing for housing sales or real estate dependent industries that thrive when people sell and buy homes, housing will remain in the doldrums.
  • Refinancing does nothing for the moribund home building industry, which depends upon “move-up” buyers.
  • It is quite likely that some – perhaps many – borrowers who refinance under HARP II, will ultimately decide to short sell, thus leaving the GSEs (aka the American taxpayer) to pay for the loss.
  • If you have negative equity the day you refinance, you’ll have it the next day too.  HARP does nothing to mitigate the oppressive psychological effect of being a high priced renter tethered to a home with no equity.
  • HARP does not deal with the heart of today’s real estate problem, which is that the banks have not, so far, agreed to make principal reductions in their loans.  Perhaps the 50-state Attorneys General can accomplish this, but time’s running out and from what I’ve seen so far, the process has been about as successful as herding cats.

Conclusion. HARP II is too little too late.  It is based upon a policy that is too tentative and too conciliatory to Big Banks.  It is nothing more than HARP I with lipstick.  Most importantly, it entirely sidesteps this country’s real estate problem, which is negative equity.  Refinancing does nothing to alleviate the direct effect of being “underwater.”  Metaphorically, homeowners are still left treading water.

Even if HARP II is a roaring success, it does not reduce or eliminate negative equity.  We don’t have another ten years to wait while homeowners dig out of bad loans.  Bold action was necessary at the start of this crisis in 2007-2008.  The Administration’s latest effort is nothing more than “extend and pretend.”

[1] I say this because realistically, the bulk of problem loans were in the 2005  – 2007 time frame.  If the loan has been in good standing for that long, the representations and warranties lose significance, since the borrower has already survived the worst part of the housing collapse and credit crunch.

[2] When a first mortgage is refinanced, the original loan is paid off and disappears from the public record.  However, if there is a second mortgage behind the first, unless the second agrees otherwise, the minute the first mortgage disappears, the second mortgage is automatically elevated to a first position.  Accordingly, in order for a refinanced first mortgage to remain in its original first position, the second lender must agree to remain subordinated.  Without such an agreement by that second lender, the first mortgage cannot be refinanced into a first position.

[3] Note: This statement assumes only one loan on a borrower’s primary residence.  Second mortgages can be problematic if the second lender is different from the first, or the second loan was made at a different time than the first loan.

[4] This is because unless the Mortgage Debt Relief Act of 2007 is extended by Congress beyond its December 31, 2012 deadline, a 2013 foreclosure sale would result in a 1099-C issued to borrowers for thousands of dollars of “phantom income” that would be taxable at their ordinary income tax rates.  If loan payments stop in 2012, there is a high likelihood that the foreclosure sale will not be completed until the following year.