By Danielle Babb, dean of business at Andrew Jackson University.Many are in favor of the Obama Housing Plan that was announced on Wednesday, February 18, 2009. It was touted as the first plan designed to help struggling homeowners who were unable to refinance because they owe more than their homes are worth. The plan would supposedly help 7 million to 9 million homeowners, with 4 million to 5 million through Freddie Mac ( FRE) and Fannie Mae ( FNM) and the rest through incentivizing banks to modify mortgages. The plan isn't all it's cracked up to be. There are several issues on both the homeowner and investor side as well as the lender and builder side that make this plan problematic in the long term. First of all, for banks to receive government assistance of any kind (I'm not in favor of banks receiving government assistance, but many banks say they need it to stay afloat), they must play by the rules of the game. The rules will require that banks modify mortgages such that the maximum debt-to-income ratio (the amount of money you spend each month on your mortgage), or DTI, for a homeowner is 31%. Historically banks have allowed 40%; even 47% if the homeowner has good credit. Bank of America ( BAC - Get Report) allowed mortgage holders to go to nearly 50% and many of us are paying those loans each month despite struggles doing so. Wells Fargo ( WFC - Get Report), even on investment properties, often bent the rules to allow a 45% DTI. Banks will write down mortgages by principle reduction, lowering rates, extending out the length of the loan or dropping payments - or all of the above - to meet the 31% DTI requirement.
The government will then split the difference with the bank. As the Economic Advisor for Vice President Biden said yesterday, we will "share the pain" -- we being the government and the banks. There is only one problem -- "we" are the taxpayers, and of those that own homes, over 90% of them are still paying on time. It seems like the "Ask not what your country can do for you..." idiom doesn't apply to everyone. The plan won't work. It doesn't address jumbo mortgages, many of which are about to reset this year and through 2011 and don't qualify for Freddie or Fannie mortgages. It doesn't address the moral hazard of so many people I read about and hear from that are literally not paying their mortgage, but instead are waiting for a government handout. It doesn't address those who are frustrated by seeing big banks and the "Big 3" given billions of our taxpayer dollars while they pay their negative amortization mortgage on a home that is $200,000 under water -- homeowners that are now encouraging their spouses to quit their jobs so they can get an even lower payment under the new 31% DTI. Worse yet? Many banks report a 50% to 70% re-default rate. Why would that be? Put yourself in the homeowners' shoes for a moment. You are living in Henderson, Nevada - hard hit by foreclosures. You owe 30% more on your mortgage than your house is worth. You received a loan modification to break even -- you are no longer under water. In a year from now, you've lost 10% more in value -- so what do you do? The same thing that worked the first time -- you re-default. This is occurring more than most people realize.
Perhaps the most toxic component of the plan is what's known as the cramdown -- allowing bankruptcy judges the ability to force lenders to write principle balances down to something affordable and reasonable by the homeowner. Last time I checked, the homeowner didn't have to sign the mortgage documents. Prices can go up; they can also go down. There are big lessons to be learned here, and getting money from those paying their mortgage to give to those who aren't, isn't the lesson we need to be learning. What might work? Why not require those who receive mortgage modifications to put all of their assets on the line before they are allowed to modify their mortgage? We require college students to sign their life savings away should they default on their college loan; why not require the same of those modifying their mortgages? Perhaps this won't return the negative stigma associated with foreclosure (we've somehow lost this, and I find this to be a bad thing as it lets people off the hook for obligations they've made), but it just might make people think twice before voluntarily allowing their homes to go back to the bank. Some are even doing what's known in the industry as "buy and bail" -- buying their new home while their credit is good, prices are low and inventory is plentiful; then bailing on the old one. Many people from various organizations and groups that I've debated these last few weeks try to convince people that the banks just aren't modifying mortgages. This simply isn't true. In fact, with 1 to 3 pages of documentation in most cases, lenders are modifying mortgages -- a default costs the local government about $20,000 and a bank about $50,000 -- the bank doesn't want your home back.
Many banks are even getting ahead of the game, with Wachovia now Wells Fargo rolling out a modification plan first to delinquent borrowers and then to those with the Wachovia "Pick a Pay" negative amortization loan. Washington Mutual , now part of JPMorgan Chase ( JPM - Get Report), is staying ahead of the game and allowing people to fill out quick documentation online -- with a response in a week or two. From a lender's perspective, many banks are going to be forced to severely write down properties to a 31% DTI when a family might be able to afford 50%. Banks will take losses forced by the government -- maybe not literally forced -- but threatened with lack of any available assistance in the future should they need it. This is a kind of corporate blackmail. Lenders will have to move staff from the sales side, which we badly need to remove inventory (the root cause of the declining value of homes), in order to manage and deal with modifications that are dictated by the government. Worse yet, they will need to bring more lobbyists to Washington to fight the cramdown that Pelosi and her court in Congress are trying to push, which would allow judges to make the decision as to what is best for a lender and homeowner. Let the private sector work this out! Homebuilders certainly won't be thrilled with this plan either. Builders like Standard Pacific ( SPF), Hovnanian ( HOV - Get Report) and Lennar ( LENB) are going to see sales suffer for quite some time; rather than buy a new home, why not owe significantly less on one you've already put time, money, and energy into? Or better yet, buy a foreclosure not saved by the Obama plan -- there will be plenty of them to go around.
This plan is highly flawed. It doesn't address the jumbo markets and the next wave of foreclosures. It doesn't address areas hard hit by speculators and investors because investors don't qualify for any part of the plan. It certainly does nothing for those who are dutifully paying their mortgage. It encourages lack of competency and accountability. It will allow refinances through Fannie and Freddie that are paid for and subsidized by the taxpayer; and when those loans default too, the taxpayer will once again be on the hook for that foreclosure. It doesn't stop people who lied on their mortgage applications the first time from lying for a modification, and it doesn't require that the homeowner put his neck on the line -- like college students have to do just to go to school. The plan isn't irrelevant however -- quite the opposite -- in fact it may hurt many honest hardworking people. Absurd is an understatement.