Never, Ever Underestimate the Stupidity of Politics

If we’ve learned anything from watching government response to this nation’s housing and economic crisis, it’s this: the more irrevocably stupid an idea is, the more likely it becomes that our politicians will tend to consider it. It’s already been proven true more than once, across two different administrations. While I was away last week on a much-needed vacation, the rest of the financial press — and politicos the nation over — found themselves lathered up over the rumor of a government-led mortgage principal forgiveness push. Reuters‘ own James Pethokoukis, a respected and politically-connected editor, was the first to give the rumors some airtime in the financial press, citing some speculative comments from Goldman Sachs and Mizuho Securities. The Treasury immediately denied the rumors. Nonetheless, more than a few investors started wondering like mad if the time had come to unload some of their precious Fannie and Freddie MBS holdings while they still could; after all, many had not accounted for even the prospect of direct government intervention wiping out much of the value of their holdings. The argument here is as simple as it is seductive: the Democrats, facing an ostensibly challenging upcoming election cycle, decide to go after some 15 million or so votes by using Fannie Mae and Freddie Mac — now wards of the state — as the instruments of principal forgiveness for underwater homeowners, via some vague expansion of the Bush administration-era Home Affordable Refinance Program, or HARP. After all, HAMP is an utter failure thus far. And despite record low mortgage rates for months now, refinancing activity remains tepid at best (especially in light of where rates currently sit). It’s now clear to everyone that extremely tight credit conditions are keeping mortgage demand below levels typically seen in the past. The average FICO on agency originations now stands north of 760 (!), according to Fannie Mae data. Researchers at Barclays Capital, for example, found that for every 100 borrowers that were 100bps in the money on their existing mortgage during 2000-2008, as many as 60% refinanced into a lower-rate mortgage when they could; by 2009-2010, that figure has fallen to just 20-25%. Some economists, most recently at Morgan Stanley, have begun to push Congress to loosen lending standards again in order to open up the refi spigot for borrowers that want access to lower mortgage rates but can’t get into a new loan. Nonetheless, it’s very unlikely the political will for such a move will exist anytime soon — after all, we got into this mess because lending standards were too lax to begin with. (And for those tough-to-fund loans, the FHA is still handing out approvals, including a new and under-appreciated short-refi program.) So how to generate even more refis? You guessed it: let’s have Uncle Sam step in and write off some mortgage principal! Dig deeper and it becomes pretty clear that the entire idea of the government stepping in and wiping out mortgage principal for some borrowers is utter and complete nonsense. But don’t let the sheer stupidity of it all fool you into thinking it can’t happen. It’s simple, it’s seductive, and it’s stupid. Sounds just like the sort of plan only a politician could love, doesn’t it? Nuts and bolts, otherwise known as the real world Technically speaking, there are all sorts of real and meaningful issues that would prevent such ‘force majeure’ refinancing — the sort of details that most financial editors like Daniel Indiviglio at The Atlantic tend to miss and/or forget in their analysis of the idea. The largest of these details is so-called put-back risk; banks will take a capital hit whenever they buy a loan out of a Fannie or Freddie MBS. Two respected research shops, at Barclays Capital and Bank of America Merrill Lynch, both highlighted the issue with put-back risk last week. For one thing, both shops note that the GSEs would have to waive their put-back fees under the program — lest the government want to place further capital pressure on the banking sector. For another, many of the largest sources of put-back risk are currently off-balance sheet in the sense that the direct originators went bankrupt (ie, WaMu) or were acquired (ie, Countrywide) — it’s not exactly in a bank’s best interest to transfer these sort of liabilities directly to it’s own balance sheet en masse, unless the GSEs also agree to waive put-back risks on new originations. And that’s just for starters. There’s also the issue of lenders and servicers alike being stretched beyond capacity already — how do you think they would handle the estimated 9 million refinances? Do you really think these refinances would be free? Barclays researchers estimate that between fees for waiving put-backs plus the transaction costs associated with refinancing, borrowers would see base contract rates that are at least 100bps higher than the no-point contract rate. But, hey, Uncle Sam would have gotten some of the principal on that old mortgage written off, so at least we’ve got that going for us. Of course, the technicals sidestep the substantial moral and social aspects the would come with Operation Big Brother Refi™ — passing on less debt to some, while expecting the rest of us to abide by the terms (and debt loads) of our original mortgage. This is an all-world stupid idea. But consider for a minute that HAMP is quite literally every bit as stupid as this — and yet it still managed to become a reality. Don’t believe me on HAMP? Consider that through May 2010, 340,000 of the 1.5 million homeowners offered trial mods had received “permanent” modifications. Even if we assume a ridiculously low 40% redefault rate on those “permanent” mods (and we don’t know the real redefault rates yet), that means 204,000 people get to keep their homes. Assuming that number triples through HAMP’s slated expiration in 2012, we’ll reach a total of 612,000 borrowers kept in their homes through HAMP. HAMP’s program cost? $50 billion. The final price tag? $82,000 or so per success. You really can’t make this kind of stupidity up. So while the idea of an August ‘surprise’ from the current Obama administration is the sort of silliness that should go unheeded because of what it truly is — absurdity — choosing to dismiss the notion simply because it’s stupid misses the point. We’ve already seen that stupid ideas can have political currency. The only question left is whether history will repeat itself. The fact that Pethokoukis has gotten zero pushback from the White House is disconcerting, to say the least. So, too, are off-the-record remarks from a government source at a recent conference I attended that hinted at principal reductions taking center stage in the back half of this year. Paul Jackson is the publisher of HousingWire magazine and HousingWire.com. Follow him on Twitter: @pjackson