The Housing and Economic Recovery Act of 2008

The housing bill President Bush signed into law last Wednesday, officially called The Housing and Economic Recovery Act of 2008, looks more like a transcription of the Odyssey in Homeric Greek than it does an attempt to help the everyday American homeowner manage the current mortgage crisis.

However, after reading through the bill itself and listening in on multiple analyst conference calls I will attempt to explain some of the contents of the bill, where it helps the current housing environment and where it falls short.

Government Purchasing GSE Securities

• GSE’s are the Government Sponsored Enterprises, known more commonly as Fannie Mae and Freddie Mac. These organizations were created by congress but are privately owned by common stockholders. Since their inception, they have had a unique, hybrid role between the public and private sector that is at the heart of today’s crisis.
• In order to prevent a widespread deterioration of the market for Fannie Mae and Freddie Mac debt, the government has been given the ability to buy any GSE security issue, whether it is debt or equity, by either agency.
• This announcement has shored up the market prices of the senior debt of both agencies and increased the confidence in their subordinated debt.
• If the government takes an equity stake in either company, it is unclear what effect this will have on the existing common and preferred shareholders.
• Treasury Secretary Paulson has said many times that he orchestrated the purchase plan as a confidence booster and doesn’t foresee the need to use it in the future.

Rising Rate of Foreclosures

• If a particular homeowner is at serious risk of default, they can apply for participation in the refinance program with the Federal Housing Administration (FHA).
• The FHA will refinance the home up to 85 percent of the newly appraised value as long as the current loan servicer agrees to forgive the outstanding principle balance above and beyond the FHA refinance.
• To qualify as seriously delinquent, the homeowner must prove that at least 31 percent of gross income is allocated to servicing mortgage debt and loan-to-value (LTV) must be greater than 90 percent.
• The FHA underwriting standards will remain strict. Therefore, jumbo loans and homeowners who cannot prove the proper documentation of income will not qualify for this program.
• By participating in the FHA program, the homeowner will sacrifice a portion of the future appreciation of the home, up to 50 percent in certain cases. This, along with a fee paid by Fannie Mae and Freddie Mac on the new securitization business, leaves some hope for this portion of the program to pay for itself.

Government Buying Homes

• A large amount of funds, about $4 billion, will go to purchasing the glut of already foreclosed homes that currently sit unoccupied.
• The future for the homes purchased by the government is still unclear. Most home purchases will be in urban areas and will most likely be refurbished and turned into government subsidized housing or simply bulldozed.

First Time Homebuyer Credit

• A credit for first time homebuyers of ten percent of the value of the home, up to $7,500, will be offered until the end of 2009.
• Although called a credit, it can be more accurately described as an interest free 15 year amortizing loan.
• For example, a $7,500 credit will be repaid with $500 added to the homebuyer’s federal tax bill every year for the next 15 years. This can be considered a small incentive at best.

New GSE Regulator

• In order to police Fannie Mae and Freddie Mac, the government has created a new regulator, The Federal Housing Finance Agency.
• In addition to assuming all of the responsibilities of its predecessor, the Federal Housing Finance Agency will have fairly open ended discretion over dividend payments, executive compensation and various other aspects of the business.

Problems and Risks with Plan

• Participation in this program is voluntary. The potential problem with this deals with the shocking number of homeowners that simply walk away from their mortgage without a single call to the lender. The lack of participation in programs for distressed borrowers that already exist poses a challenge for this new program.
• It will be important to see the principle amounts that loan servicers are willing to forgive. If they are too stringent it may be hard for this plan to get off the ground. It is the responsibility of the loan servicer to maximize the present value of the loan so this will be a difficult decision on their part. It is scary to think that 30 to 40 percent or more principle forgiveness is needed for some borrowers to qualify for this program.
• Although $4 billion will go towards converting foreclosed property to government subsidized housing, the bulk of the problem lies in suburban homes that are much larger and were purchased by people who couldn’t afford the homes and relied too much on the expectation of continued appreciation. These borrowers won’t qualify for the FHA refinance program because their home value exceeds the limit or they can’t document the level of income needed (or both).

The Long and the Short

The Housing and Economic Recovery Act of 2008 should not be looked at as a “cure all” for the problems that plague the current housing market. If participation in the program goes well it could help to create a bottom for declining home values and reinstate traditional liquidity in housing.