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Buoying Underwater Homeowners to Rescue the Economy
By Anne Kim on 08/02/2012 @ 11:00 AM
With fresh news of a slowdown in growth—the economy grew at just a 1.5% annual rate last quarter—there’s new urgency for measures to jumpstart the recovery. Among the factors dragging down the economy is housing, which despite some recent good news is still lagging.
In particular, the market is still struggling to deal with the roughly eight million homeowners who are “underwater”—owing more on their mortgages than their homes are worth.
These borrowers might be current on their mortgages but lack the equity to qualify for a refinancing into a lower-interest loan. They might be trapped in their homes, unable to sell or to move to areas with greater economic opportunities. As a consequence, they’re more likely to default, which in turn compounds the foreclosure crisis and puts even more downward pressure on home prices.
Last week, Senator Jeff Merkley (D-Ore.) proposed one bold and creative solution for helping both the American economy and these underwater homeowners. His idea: To allow any American who is current on their mortgage and meets certain underwriting standards to refinance into a 4% loan.
Under Sen. Merkley’s plan, homeowners would have three refinancing options: (1) a 15-year loan at 4% interest; (2) a 30-year loan at 5%; or (3) a two-part mortgage, the first on 95% of a home’s current value and the remainder a “soft second.”
In a white paper released by his office, Sen. Merkley argues the benefits of refinancing underwater borrowers:
“Families would benefit from loans that rebuild their equity more quickly or that reduce substantially their monthly payments. The reduced rate of foreclosures that would result would strengthen communities and help to stabilize or grow housing prices, improving the home construction economy and other sectors tied to the housing market. Moreover, the greater spending power of these families would help improve the overall economy.”
Sen. Merkley’s proposal builds on President Obama’s call for a “grand refi” during his State of the Union address this year and follows in the footsteps of similar, bipartisan proposals championed by Senators Barbara Boxer (D-Calif.), Johnny Isakson (R-Ga.), Bob Menendez (D-NJ) and Rep. Dennis Cardoza (D-Calif.).
Like these other proposals, it is worthy of serious consideration.
Most significantly, it tackles head-on the continuing problem of “negative equity.” Underwater borrowers can’t currently refinance, despite historically low interest rates, because they don’t have enough equity to qualify. The extra interest they’re paying crowds out other priorities, such as saving for college or retirement savings.
Negative equity is not only at the root of the housing downturn, it’s also at the heart of Americans’ catastrophic loss of wealth since the start of the economic crisis.
According to the Federal Reserve’s Survey of Consumer Finances, the crash wiped out nearly two decades of accumulated wealth, with housing accounting for nearly three-fourths of those losses. Americans are not only poorer than they were before the crash, they’re saving less and are less prepared to survive, let alone succeed.
A defining challenge over the next decade will be how to rebuild America’s lost wealth and potential for economic opportunity. Restoring homeownership will be central to meeing that challenge—a view that CFED has long championed.
Second, Sen. Merkley’s proposal has the benefit of bypassing Congress, which is effectively out of commission until after the November elections. The Merkley plan would be administered through a “Rebuilding American Homeownership Trust,” to be housed in the Federal Housing Administration, the Federal Home Loan Banks or the Federal Reserve, and would require no legislation to create.
Of course there are potential concerns. The proposal doesn’t spell out the underwriting standards borrowers would have to meet to qualify or the extent of the fees that would be charged. Nor is it clear that private lenders would readily participate. All of these are factors potentially limiting the program’s reach. Funding is another concern, particularly if default rates on the refinanced mortgages are significantly higher than expected. While the white paper makes a strong case that this plan will pose no net burden on taxpayers, this case rests on assumptions that may or may not bear out with time.
Nor is the plan immune from politics. For example, the proposal doesn’t choose among the three possible agencies that are homes for this program. Moreover, from a PR standpoint, it may be difficult to help jaded and skeptical homeowners differentiate this program from the apparent failures of HARP and HAMP. And given the current hostility to “big government,” whatever its form, Americans may reject the idea of a new government-administered trust, even for what should be a politically popular purpose.
Nevertheless, Sen. Merkley deserves kudos for offering a carefully-conceived proposal that seeks to help restore the fortunes and economic security of millions of Americans. And in the current pre-election environment where politics trumps substance, his bold call to action stands out as an example of what policymaking could and should be.
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