Votes stimulas? Obama Admin squashes rumors of mortgage bailout before midterm elections

Reuters reported that Main Street may be about to get its own gigantic bailout. Rumors are running wild from Washington to Wall Street that the Obama administration is about to order government-controlled lenders Fannie Mae and Freddie Mac to forgive a portion of the mortgage debt of millions of Americans who owe more than what their homes are worth. An estimated 15 million U.S. mortgages – one in five – are underwater with negative equity of some $800 billion. Recall that on Christmas Eve 2009, the Treasury Department waived a $400 billion limit on financial assistance to Fannie and Freddie, pledging unlimited help. The actual vehicle for the bailout could be the Bush-era Home Affordable Refinance Program, or HARP, a sister program to Obama’s loan modification effort. HARP was just extended through June 30, 2011.

The move, if it happens, would be a stunning political and economic bombshell less than 100 days before a midterm election in which Democrats are currently expected to suffer massive, if not historic losses. The key date to watch is August 17 when the Treasury Department holds a much-hyped meeting on the future of Fannie and Freddie. A few key points:

1) Republican leaders believe this is going to happen since GOPers and Democratic moderates in the Senate are unwilling to spend more taxpayer money on more stimulus. But such a housing plan would allow the White House to sidestep congressional objections and show voters it is doing something tangible about an economy that seems to be weakening.

2) Wall Street banks are alerting their clients privately to this possibility. Here is what some are cautiously saying publicly. This from Goldman Sachs:

GSE policies are one of a dwindling number of policy levers the administration has left to pull, so it is conceivable that changes could be made, though there is no sign that a policy change is imminent. The Treasury’s essentially unlimited ability to provide financial support to the GSEs creates an interesting situation over the next twelve months: the GSEs could potentially be used to provide additional support for the housing market and, to a lesser extent, the broader economy in 2H 2001.

And this from Mizuho Securities:

As policy makers ponder their next move the data suggests that they face not only a stalling recovery but a growing risk of deflation taking root in the economy. As a result, the Administration has turned back to industrial policies by approving the purchase of a sub-prime auto lender by GM as a means for pumping up domestic sales, especially since the latest auto sales data indicates that consumers are still responsive to incentives. This precedent increases the risk that the government will use its control of Fannie and Freddie to increase consumer cash flow and juice the economy again.

Moreover, Morgan Stanley is pushing a mortgage relief plan directly to Congress. On August 3, a top Morgan Stanley economist recommended to the Senate Budget Committee that Fannie and Freddie ease their lending standards to allow millions of Americans to refinance their mortgages.

3) Keep in mind the political and economic context. The nascent recovery is already running out of steam. Wall Street economists just downgraded the government’s second-quarter GDP estimate of 2.4 percent to around 1.7 percent. And as even Treasury Secretary Timothy Geithner is warning, the unemployment rate may well begin to rise back toward the politically toxic 10 percent level given such sluggish growth. Many in the White House thought the unemployment rate would be dropping sharply by this point in the recovery.

But that is not happening. What is happening is that the president’s approval ratings are continuing to erode, as are Democratic election polls. Democrats are in real danger of losing the House and almost losing the Senate. The mortgage Hail Mary would be a last-gasp effort to prevent this from happening and to save the Obama agenda. The political calculation is that the number of grateful Americans would be greater than those offended that they — and their children and their grandchildren — would be paying for someone else’s mortgage woes.

4) And don’t think the White House is worried about financial market reaction. If they thought it would pass Congress, they would be submitting a $200 billion Stimulus 2.0 (3.0?, 4.0?) right now.

August is supposed to be a slow month for Washington politics. But maybe not this one.

However- the Wall Street Journal reports:

Federal Officials: No Plans for Expanding Refinance Programs

Obama administration officials knocked down rumors on Thursday about any plan for new programs–dubbed an “August Surprise” –to streamline refinancing or cut mortgage balances for homeowners in a bid to stimulate the economy without asking Congress for money ahead of the midterm elections.

Speculation has intensified over the past week as some economists have proposed that the government put cash in more Americans’ pockets by making it easier to refinance. A news report on Thursday suggested that such stimulus might also include a plan to lower mortgage balances for some homeowners.

These reports have worried mortgage investors, sending prices down. But elements of the so-called surprise programs already exist in far more modest forms and there are no plans expand them, administration officials said. The Obama administration said in March that it would create a pair of programs later this year that would allow mortgage servicers and investors to voluntarily reduce loans balances.

One of those programs—which hasn’t been finalized yet but will be soon—will allow mortgage investors to refinance current homeowners who are underwater, or owe more than their homes are worth, into loans backed by the Federal Housing Administration if investors are willing to take a haircut.

And it already has had for more than one year a separate program that allows some homeowners to refinance underwater loans. That initiative—called Home Affordable Refinance Program, or HARP—has fallen short of its initial goals.

Administration officials dismissed the idea that something bigger might be in the works. “The Administration is not considering a change in policy in this area,” said a Treasury Department spokesman.

What about a program to “streamline” refinance borrowers without regard for their credit scores or equity position? “There is not any plan for expanding into a high [loan-to-value] refinance program at this time,” said FHA Commissioner David Stevens.

Economists and mortgage analysts have suggested that the government could easily create economic stimulus by removing barriers to refinancing. Mortgage rates continue to reach record lows: the weekly survey of 30-year fixed-rate loans by Freddie Mac averaged 4.49%, an all-time record. Rates on 15-year fixed-rate loans averaged 3.95%, also a record.

But millions of borrowers haven’t taken advantage of those rates because they can’t qualify—their incomes have fallen, their credit score isn’t pristine, or they don’t have much or any home equity—or because they don’t want to pay higher refinance fees. Morgan Stanley economist David Greenlaw last week said that the government could produce $46 billion in savings by refinancing 37 million loans held or guaranteed by Fannie Mae, Freddie Mac, or government agencies.

But there are reasons to be skeptical that the government would adopt such a program now. First, it would be hard to make it work, and the administration knows this all too well. Both HARP and the companion modification program, HAMP (Home Affordable Modification Program), have had numerous frictions that have hindered their effectiveness. Banks have struggled to implement the program and borrowers haven’t participated near the levels expected. Rather than create an entirely new program—which could take weeks if not months to get running—the administration is more likely to make tweaks to the programs it has already built.

And it’s still not clear how much economic punch such a program could pack. Analysts at Goldman Sachs and Credit Suisse say such a program would generate an average annual savings of $15 billion, about one third of Mr. Greenlaw’s estimate, while analysts at Barclays Capital say the actual savings would be even lower, at around $6 billion annually.

Another problem, this type of stimulus isn’t free. Even though the government wouldn’t pay for it, mortgage investors would because the loans they thought had a certain return would pay off sooner than expected, leaving investors with money to invest at lower rates.

“It would be far from costless for the banks, [Fannie and Freddie], mutual fund investors, sovereign portfolios and other institutions now holding agency [mortgage-backed securities]. They would be the providers of the windfall,” writes Deutsche Bank analyst Steven Abrahams. “Given the substantial resources invested in rebuilding bank capital and bringing the sector back to full strength, the impact of ruthless refinancing might give policymakers reason to pause.”

Ultimately, investors would price that uncertainty into mortgages, raising rates for future borrowers. Mr. Abrahams estimates that such a program could raise future borrowers’ rates by 0.4 percentage points.

In addition, such a proposal would ostensibly be designed to improve the economy before the midterm elections, but the politics aren’t as obvious at they seem. Helping some homeowners could breed resentment that another favored political class is getting a bailout. And if any of those moves were to create bigger losses for Fannie Mae and Freddie Mac, that puts an even brighter spotlight on those wards of the state, whose futures are about to be addressed by the administration.

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