The Obama Administration has announced its Homeowner Affordability and Stability Plan (HASP).  What problems are these efforts attempting to address?  And how significant are they likely to be in addressing the current problems in the housing market?

HASP is a very limited plan with a large price tag. It is directed primarily towards helping two groups of homeowners with conforming mortgages (meaning that the loans met Freddie and Fannie’s requirements in their terms and conditions and were eligible to be purchased by these two GSEs).  The first group consists of 4-5 million homeowners who are presently current on what had been conforming mortgages but who can’t refinance because the decline in house prices put their loans underwater.  The second group consists of about 6 million homeowners with conforming mortgages who are in imminent danger of going into default.  The plan would provide financial incentives for lenders to renegotiate loans not only on conforming loans but on other loans as well.  The government would also inject more capital into Freddie and Fannie and permit them to expand their holdings of mortgages in their own portfolios in an attempt to lower mortgage rates, and in a parallel effort the Federal Reserve would expand its purchase of mortgage-related assets.  Finally, the program proposes additional reforms to help families stay in homes that would otherwise be foreclosed upon by permitting judges to modify loan terms and conditions (so-called “cram-downs”).  All together, the plan has an estimated price tag of $275 billion.

What problems are these programs designed to solve?  The answer is that they are largely directed towards prospective problems and not the existing problems in the mortgage market.  For example, just because a loan is underwater doesn’t mean that mortgage payments can’t be made or that the loan can’t be refinanced.  At this time, helping that first group of homeowners seems like a second- or third-order problem. Likewise, while mortgage renegotiation may be beneficial to homeowners and to lenders to avoid the costs of foreclosure, this is a preventative step to keep the potential supply of foreclosed homes from growing.  Perhaps an analogy that could be used to characterize this effort is that it is like a group of emergency-room doctors, surrounded by sick and injured patients, focusing their efforts on administering flu shots to the healthy people in the room who were exposed to the flu.

During the 2000-2006 period there was a huge surge in overbuilding, which resulted in an excess supply of housing.  Prices began to decline in 2006, and then the lowest-quality loans – namely, subprime loans with high leverage and poor payment prospects – triggered the financial crisis.  In particular, it was the nonconforming segments of the mortgage loan market, specifically subprime, Alt-A, and jumbo loans, in the most heavily overbuilt areas like Southern California, Arizona, Nevada, and South Florida where the big problems emerged.  Default rates on subprime loans were the first to take off and are now at 20%, as of the end of Q3 2008 (the latest available data).  Moreover, the performance in terms of delinquencies for loans originated in 2006 and 2007 is substantially worse than for similar loans made in earlier years – a reflection of the serial relaxation of lending standards during the period. As a proportion of the total mortgage loans outstanding, subprime loans amount to about $1 trillion or some 9% of the outstanding $11.1 trillion of mortgage loans.  In contrast, default rates on prime mortgages (which include so-called Alt-A loans) have nearly doubled, but remain at about 3%.

The first step in addressing a crisis should be triage with the most critical problems being tackled first.  These are the problems of excess supply of houses on the market; the decline in housing prices, especially in certain areas of the country like California and Florida; and the effects that already delinquent subprime and Alt-A and defaulted mortgages are having on both the housing market and financial institution balance sheets.  The supply of existing homes on the market has come down significantly but has a long way to go and, unfortunately, this will take some time to be resolved.  Taking the excess supply off the market will require growth in population and family formations and increases in the home ownership rate (but putting unqualified borrowers into loans they can’t afford isn’t a viable solution).  It will also require policy makers to hold their noses and address the problems the subprime market has caused, which may require bailing out some borrowers and lenders who abused the system. 

Increasing the supply of mortgages on the market and/or lowering mortgage rates even further will accelerate refinancing efforts, which is part of the Obama plan, and will induce existing homeowners to move, but will not reduce the oversupply of homes on the market.  Unfortunately, the current relief efforts are not directed primarily toward the key problems; and interestingly, they will have minimal effect on the housing situation in California or South Florida.  In the meantime, taxpayer dollars are being diverted from addressing existing problems in an attempt to prevent the development of new problems.  This is not triage.