Here Comes The Cavalry Again

The U.S. Department of Treasury has just released details on its mortgage modification plan. For a link to the actual PDFs (replete with typos by the by), click here. Otherwise, here's a brief summary as far as I can understand it:

The plan is separated into three components: 1) the "Home Affordable Refinance Program," 2) the "Home Affordable Modification Program" and 3) the plan to "Support Low Mortgage Rates". I can only imagine that the Yoda-esque syntax is employed to inspire confidence.

Part 1: The Home Affordable Refinance Program:

• Homeowners who owe more than 80% the value on their home (e.g. someone who owes $450,000 on a $500,000 home) and who took out loans owned or guaranteed by either Fannie Mae or Freddie Mac will be eligible to refinance through either of those two companies.
  
• Refinancing allows borrowers to renegotiate the interest rate of the loan and/or to fix rates that are currently adjustable. I don't think this allows people to reduce the premium, but I only say this because such a provision isn't mentioned explicitly.
• With 20% of homeowners now "underwater" (owing more than 100% of the value of their home due to falling house prices) and Fannie and Freddie stand behind about half of all mortgages in the U.S. (and probably a substantially higher proportion of troubled ones, since their mandate is to buy and ensure mortgages made to lower income borrowers), the Obama people estimate that this portion of the plan will directly effect 4-5 million borrowers.

Part 2: the Home Affordable Modification Program

• Lenders will be encouraged to reduce all mortgage rates so that monthly payments do not exceed 38% of the borrowers monthly income. The rates will then be lowered further at the cost of the U.S. government until the debt-t0-income ratio is reduced to 31%. Rates will then be capped for five-years and restricted in rate growth of 1% a year afterward.
• As far as I understand it, compliance with the above plan isn't mandated. Instead, servicers (those who manage and collect debt payments) will received $1000 per modification, plus $1000 annually for the next three years assuming the loan is still performing (i.e. the borrower has not defaulted).
• Additional payments to both servicers and borrowers will be added if the loan is restructured before the first missed payment. The rational here is that "loan modifications are more likely to succeed if they are made before a borrower misses a payment." I don't know why that would be the case, but let's assume that's true.
• At the moment, because house prices are expected to decline for some time, there is an incentive to foreclose and sell off the asset now, rather than to wait for prices to decline further. To offset that incentive, servicers and mortgage holders who remodify will be partially compensated for subsequent home price declines.
  

Part 3: Supporting Low Mortgage Rates

• Using previously allocated money (Housing and Economic Recovery Act), the Treasury will further subsidize Freddie and Fannie to buy mortgages from private banks, thus freeing up liquidity and, hopefully, keeping down mortgage rates.
• The Treasury will step up its purchases of Fannie and Freddie securities, similarly freeing up liquidity for those two GSEs.
• Increasing the amount of mortgages that Fannie and Freddie can hold at one time and expanding their level of allowable debt outstanding

And that, as far as I can interpret it or bother to read, is that. Overall, it seems like a good plan, though obviously the devil of our impending financial ruin will be in the details (and in the potential incompetence with which the whole thing is executed).

If I may add one more point, and one which came up in a conversation between Dave, Lion and I in Barcelona--wooo! Barcelona! Chorizo shots for everyone!--home price stability is secondary in importance to relative income stability. As I wrote before, because home prices are falling so quickly, 20% of all homeowners owe more on their mortgages than they could realistically expect to get by selling their home. While this is certainly a scary statistic, debt isn't necessary a big problem as long as it can be paid back. This is particularly true in the case of the modern mortgage industry, where a series of defaults on home loans will not only wipe out borrowers and lenders, but insurance underwriters and secondary market sellers and unwitting mortgage backed security holders and...

The central problem is not falling home prices--falling prices are a symptom of an inability on the part of borrowers to payback loans and of a desperation on the part of lenders to get their hands on some much needed cash. In any event, only now are nation-wide home prices starting to descend from the twilight zone which they have blissfully inhabited for the past six years. Instead, our priority should be to keep debt payments in line with income declines and, on a macro level, to keep people from losing their jobs. As far as I can tell, the plan summarized above seems to address the former issue fairly well, but I'd be interested in hearing other opinions.