Hmm this would be quite a big deal if it turned out to be true.
Main Street may be about to get its own gigantic bailout. Rumors are running wild from Washington to Wall Street that the Obama administration is about to order government-controlled lenders Fannie Mae and Freddie Mac to forgive a portion of the mortgage debt of millions of Americans who owe more than what their homes are worth. An estimated 15 million U.S. mortgages – one in five – are underwater with negative equity of some $800 billion. Recall that on Christmas Eve 2009, the Treasury Department waived a $400 billion limit on financial assistance to Fannie and Freddie, pledging unlimited help. The actual vehicle for the bailout could be the Bush-era Home Affordable Refinance Program, or HARP, a sister program to Obama’s loan modification effort. HARP was just extended through June 30, 2011.
That loan modification effort was a dismal failure but Fannie or Freddie forgiving the underwater portion of your home loan is a big deal. People would open mortgage bills that Freddie and Fannie owned and see that it suddenly dropped by $200 - $300 or more. They will also find out that their home was suddenly worth far less. Is the government going to hand people the difference between what their house was worth and what it will be worth now? I can see this screwing up anyone that:
1. Paid their mortgage already
2. People that decided to rent instead of buy during the boom years
3. Decided to put down a 20% down payment and lived within their means by getting a decent mortgage
4. Have a bank/hedge fund/foreign company own their mortgage and not Freddie and Fannie
I wonder what it will do to the housing market because is will effectively drop home prices by a certain percentage. I guess it would be the equivalent of buying a stock on margin at $40, then seeing it drop to $30. Then the government comes in and says it was worth $30 all along. Is the stock worth $40 like when you purchased it? Or is it worth $30 like the government is saying? Will the government reimburse the $10 loss or will you just pay on credit on $30 and not $40?
What it might also do is wreak havoc on financial stocks. What would happen if a bank suddenly saw home prices drop by 20% as mandated by the government. They would be pressured by irate customers into following suit with their own loan portfolios in order to compete with the cuts by Freddie and Fannie. So the banks get to take their haircut on the loan right now and not defer it until whenever. Those bank stress tests better be real or we might see another wave of banking bankruptcies if this thing is done wrong.
Also what would happen to 2nd tier loans and home equity lines of credit. They were all set for when the home was worth more. Will they be reset to reflect the lower prices? Would the bank be forced to take a haircut on these loans too?
The other thing that it could effect is property taxes. Will the tax assessment by trimmed by the new value of the home? Will this result in state revenue being slashed by this loan forgiveness scheme? They just bailed out the states to the tune of several billion dollars in a "jobs" bill. Will the Feds suddenly take more money away from the revenue side of state income statements?
I guess all this means more uncertainty will get injected into the market as this stuff moves from rumor mill to the real world. The day to watch is August 17 when the fate of Fannie and Freddie will be decided by Treasury. If they do it wrong there might be a raft of unintended consequences after that date.
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