TARP For Main Street (Finally!)

Our guest blogger is Andrew Jakabovics, the Associate Director for Housing and Economics at the Center for American Progress Action Fund.

Today, the Obama Administration will be announcing several new initiatives to bring relief to homeowners struggling to pay their mortgages. But the big news is that the administration has come up with the first systematic set of policies to address the problem of negative equity (homeowners owing more than their home is worth) by bringing mortgages down to the current value of the properties.

An estimated 24 percent of all houses with mortgages are worth less than the remaining balance on those mortgages. By writing down the outstanding loan to bring it in line with the current value of the property, there is an opportunity to create mortgages that are likely to keep paying over the long term and minimize the walkaway risk.

Since the housing crisis began, CAP has argued that the best solution is to restructure mortgages to reflect current property values. Drawing on the experience of history, the new FHA/TARP program announced today fits the bill.

In what is essentially a modern version of the New Deal’s Home Owners’ Loan Corporation, a borrower who is current on her loan but who owes more on her home than it is currently worth can refinance into an FHA loan for 97 percent of the property’s current value. Incentives will be paid to servicers to allow these borrowers to refinance for less than the outstanding amount. Given the much larger losses lienholders would face if borrowers defaulted, cash in hand may be sufficiently attractive to allow these short-refis to proceed.

Even though these refis will be FHA loans in all respects and must qualify on those terms, TARP will be on the hook for future claims, with $14 billion in TARP funds being set aside for this program in a first loss position. As an added benefit, the program will also bolster FHA’s insurance fund, whose excess reserves are below their statutory minimum, since premiums will be paid into the fund but claims will first be drawn down from TARP.

For HAMP-eligible borrowers, the Net Present Value test will now be run a second time to calculate the value of a modification that includes a principal writedown. In most instances, principal writedowns will probably be more valuable compared to the current HAMP modifications, because of the reduced redefault risk from a lower loan-to-value ratio. The amount forgiven will be deducted from the loan balance over the course of the next three years, as long as the borrower remains current on their loan.

Banks have also begun to offer principal reductions for loans they originated and hold in portfolio, recognizing the value in reducing the risk of redefault. Earlier this week, Bank of America announced its own program of principal reductions for borrowers with certain exotic mortgages; while the new program is expected to reach only 45,000 borrowers, the rationale behind principal reductions should argue for the program’s rapid expansion to their entire servicing portfolio.

Taken together with the administration’s initiatives, it is clear that a consensus is emerging that principal reductions are an important tool in preventing foreclosures, as CAP has been advocating since 2007. To be sure, implementing these changes to HAMP will be difficult, and the issue of second liens remains a challenge, but insofar as the FHA refi program can largely sidestep the issue of servicer capacity, it has significant potential to alleviate the foreclosure crisis.