Bush’s Mainly Cosmetic Homeowner Rescue Proposals

The Wall Street Journal, in “Bush Moves to Aid Homeowners,” reports that today the President will set forth a program to help stressed borrowers at risk of losing their homes. Main elements:

Allowing the FHA to guarantee loans to borrowers who are at least 90 days behind on their mortgages but still living in their homes;

Temporarily suspending the income taxes charged on cancelled debt when a house is sold or refinanced for less than the amount of the outstanding mortgage.

No wonder Bush chose the deadest Friday in the summer for this announcement. There’s much less here than meets the eye.

Now admittedly, the tax relief on cancelled debt is a big item and will at least keep those who suffered the indignity and cost of giving up their home from carrying the further financial millstone of a big IRS bill. But this is aid to those who have already given up their house. It doesn’t salvage anyone.

The FHA move is largely cosmetic. Even as envisioned, the Journal tells us it will help relatively few people:

By allowing the agency to back loans for delinquent borrowers, the FHA estimates it can help an additional 80,000 homeowners qualify for refinancing in 2008, bringing its total of refinancing guarantees to about 240,000, senior administration officials said. Mr. Bush also plans to announce that the FHA will begin charging “risk-based” premiums, a move that will enable the agency to help riskier borrowers since they can charge those individuals higher insurance rates. Right now, FHA premiums are a flat 1.5% of the loan, and the change would give the FHA flexibility to charge some borrowers as much as 2.2%.

Still, the move will help only a small portion of homeowners — and few in high-cost states such as California or New York — because the FHA faces constraints on the size of the loans it can back and strict rules that borrowers must meet. The Bush administration has been pushing Congress to enact overhauls that would eliminate the required 3% down payment and raise the size of the loans the FHA can insure to as much as $417,000 from $362,790.

Note this measure is an administrative change; Senate Banking Committee chairman Christopher Dodd plans to sponsor an FHA bill that will presumably extend its reach.

The fact that a borrower has to be 90 days in default before he can start the FHA process (and who knows how speedy that will be) may not be fast enough to rescue some homeowners. While most states deliberately make foreclosure a protracted process, in Georgia, it can take as little as 60 days from a mortgage borrower being declared in default to his house being seized.

The Wall Street Journal unwittingly implies Bush may be grasping at straws to find other remedies:

In another move, Mr. Paulson and HUD Secretary Alphonso Jackson have instructed their staffs to begin working with mortgage lenders and others to identify borrowers who are in danger of defaulting. They also are trying to work with private lenders and mortgage giants Fannie Mae and Freddie Mac to develop loans for borrowers who will likely face default if they can’t get more flexible terms.

Perhaps the author was a bit careless in how she wrote this up, but “working with mortgage lenders” is not the place to find borrowers in trouble. The great majority of housing loans went into mortgage securities, which means the party that needs to be consulted is the mortgage servicer. If Paulson and Jackson actually said they want to talk to mortgage lenders, they haven’t even started to engage this problem seriously.

Ditto the comment about “trying to work with….Fannie Mae and Freddie Mac.” That is pure spin. As Financial Times commentator John Dizard tells us in “Fannie, Freddie to the rescue? Don’t bet on it“:

At a time when America, or at least Wall Street, needs a spineless hack as the head of a key agency, it is saddled with a credible man of principle: James Lockhart, OFHEO’s director. Yale graduate, Harvard MBA, lieutenant in the nuclear navy, risk management software entrepreneur, senior insurance executive, and former head of the Pension Benefit Guarantee Corporation. “A real hard-ass” in the words of a mortgage finance executive. It doesn’t seem as though he can be intimidated by the threat of being sent back to Plano, Texas, to work in his uncle’s car dealership.

Lockhart was appointed in the middle of last year to the directorship when there was no immediate, obvious cost to anyone of having a competent, effective regulator who actually knows what those buttons on his computer are connected to.

What is worse, his resistance to Fannie and Freddie ballooning their balance sheets and loosening their controls is reinforced by his experience in a previous job. The Pension Benefit Guarantee Corporation, a thinly capitalised government insurance operation, which charged inadequate premiums for covering beneficiaries of failed pension funds, was in turnround, as they say in Hollywood, during his tenure from 1989 to 1993. Lockhart had to clean up other peoples’ messes and one can guess he doesn’t want to do that again.

So it will only be after many more problems surface and under strict conditionality that F&F will pump a bunch of new money into the housing finance pipelines. Enjoy this trading rally while you can. Try not to think about the nasty surprises that could still be out there.

Update 9/1, 1:20 AM: Dean Baker is also unimpressed with the Bush proposals for different reasons:

First, according to the Post article, the plan would allow the Federal Housing Administration (FHA) to waive the current 3 percent equity requirement and allow it to insure mortgages that exceed the market value of the home. In other words, the FHA will be helping moderate income homeowners to borrow $200,000 on a home that is worth $180,000. That doesn’t sound like a very good plan for the homeowner and is probably not an especially good use of government money. It essentially means paying off the current mortgage holder — who otherwise would be holding bad debt — with taxpayer money.

The other item that deserved some additional attention is the plan to temporarily waive the taxation on forgiven debts. The deal here is that if someone owes $400,000 on a home, which is subsequently sold in foreclosure for $350,000, then they have had $50,000 of debt forgiven. Under currently tax rules, this $50,000 is treated as taxable income. According to both the Post and Times, Bush’s plan would at least temporarily exempt this money from taxation.

It is important to recognize that most moderate income homeowners will face relatively low tax rates, so this tax break will probably not be of much benefit. On the other hand, many of the people now defaulting on their loans were relatively affluent people who were speculating in real estate. In the example given here, if an investor was in the 33 percent tax bracket, President Bush’s tax break would be worth $16,500, more than twice the average annual TANF payment for a family of four.

Baker notes in an addendum that the plan isn’t as awful as the press made it sound. Tax relief will be available only to those who had owner-occupied homes, and will be capped. The FHA plan would keep in place the requirement that homeowners put up 3% of the equity.