Let the principal reduction begin. The new FHA "Short Refi" program, announced earlier this year, went into operation yesterday. It allows borrowers who are current on their mortgages now to refinance into FHA-backed loans, if and only if their lenders agree to write down the principal balance on the loan by at least 10 percent. After the refi, the primary loan must have a loan-to-value ratio of no more than 97.75 percent.
The FHA calls this a "life line" to borrowers with negative equity. In reality, it's trying to give underwater borrowers some skin in the game again and prevent them from walking away from their mortgage commitments. Interestingly, though, the GSE's, Fannie Mae and Freddie Mac , which own or guarantee around half of the outstanding loans in this country ($5.7 trillion), are not currently participating in the program. I asked FHA Commissioner David Stevens why not?
"The initial focus has been on ensuring that the expanded refinance opportunity is up and running for underwater borrowers that were viewed as most likely to be able to benefit from these program expansions if their lender agrees to write down their principal by a minimum of 10%," Stevens answered. "The Administration plans to make this available for borrowers whose loans are guaranteed by the GSE's as well."
He did not give a timeline as to when, and you will note he said the loans "guaranteed," not held by the GSE's. He also emphasized the investor write down requirement, and cautioned that investors will only participate if it "makes sense for them economically." He said the GSE's are currently considering it for the loans they hold on their books and the ones they sold off in securities.
But that could prove difficult. "Fannie and Freddie (as well as FHA and Ginnie Mae) are bound by a number of security/investor contracts that effectively prevent the government from unilaterally changing the terms of mortgages they are involved with," notes Guy Cecala of Inside Mortgage Finance. "The success of the MBS market is largely based on these private – and government blessed – contracts." And he adds that FHA and VA loans are not eligible for the Short Refi program.
Remember, the government's Home Affordable Refinance Program (HARP) has already refinanced thousands of Fannie and Freddie borrowers, but that program does not require principal write down like the FHA refi. Only about 12 percent of GSE mortgages outstanding have LTVs over 100 percent, according to Inside Mortgage Finance, so it wouldn't be a huge loss if they didn't participate. Still...
"We do believe that this program could make sense to investors in a wide variety of circumstances, including the GSE's," Stevens adds, and then continues: "The GSE's are independent companies under conservatorship. Decisions they would make, we assume, would be based on their view of likely performance expectations. Whether portfolio loans or in securities, if they allow principal write down as part of FHA refinance, it is our assumption they will be making the best decision for sustainable long term performance."
Stevens refers to the GSE's as "independent companies," and makes it sound as if any decision they make is based purely on the financials. But it's here, with all due respect, I beg to differ. Yes, the GSE's are under "conservatorship," but the Federal Government has so far infused $148 billion into the two and earlier this year the Congressional Budget Office estimated the total tab could run as high as $300 billion. This bailout money, unlike, say, AIG's bailout is unlikely to be paid back in any fashion. These are not independent companies by any stretch. If they were, they'd be out of business. I don't believe for one second that the GSE's considering principal write down right is purely financial; it is largely political.
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