Statement on Obama Administration's Housing Initiative

Dean Baker released the following statement today regarding the Obama
Administration's overhaul of its foreclosure prevention program:

The
latest Obama Administration initiative aimed at easing the nation's
foreclosure crisis may be well-intentioned, but fails to give proper
consideration to the state of the housing market. The biggest winners
are likely once again to be the banks. In particular, holders of second
mortgages are likely to see this program as a huge bonanza.

The
program provides a substantial incentive for holders of first mortgages
to reduce principal by having the Federal Housing Authority (FHA)
guarantee a new loan at 97.75 percent of the current market value. In
many cases this would be far more than the holder of the first mortgage
would collect if the loan went through a foreclosure process. However,
the payment on the second mortgage would be unaffected.

By
substantially reducing the required payment on the first mortgage, the
program will be creating a situation in which the second mortgage -
which would be worth little or nothing in foreclosure - will suddenly
again hold considerable value. This will be a huge windfall for second
mortgage holders. It is worth noting that the major banks have vast
portfolios of second mortgages.

In the current market, the newly
guaranteed FHA loans are likely to incur substantial losses. Nationwide
home prices remain about 15 percent above their long-term trend. There
is an enormous oversupply of housing at present as indicated by falling
rents and a record nationwide vacancy rate. In addition, there will be
an obvious problem of adverse selection as lenders will be most likely
to take advantage of this principal write-down process in markets where
prices are expected to fall further.

If the purpose of this
modification program is to help homeowners, then any policy must ask two
simple questions.

1. Is the homeowner paying less in ownership costs than they would to
   rent a comparable unit?
2. Is the homeowner likely to end up with equity in their home if they
   sell it in the next 3-5 years?

Both of these questions require an assessment of specific housing
markets. If the market is still bubble-inflated, then the answers to
these questions will be no and any money spent on modifications will be
helping banks, not homeowners.

For some reason there is an
enormous reluctance to ask these basic questions about the housing
market. The failure to ask these questions in the years 2002-2006
provided the basis for the housing bubble. The government still failed
to ask these questions last year as the FHA hugely expanded its role in
the housing market. The result was that the FHA lost tens of billions of
dollars and fell below its minimal capital requirements. The continuing
failure to consider the state of the housing market when designing
policy can only lead to further losses to taxpayers in ways that provide
no benefit to homeowners.