There are two parts to the plan – a refinance plan and a lower payment plan.Banker Guy also describes an aspect I'm not sure Robert Gibbs fully described when he suggested that Santelli download, print, and read the plan:
The refinance plan applies only to those whose loan is owned or securitized by Fannie or Freddie. This part actually will work. What this part really does is reduce underwriting criteria at Fannie and Freddie. It enables homeowners whose loan-to-value ratio would be over 80% to qualify to refinance. Refinancing to lower your interest rate is good; lowering credit criteria to do it is not good. But then Fan and Fred already have exposure to the collateral (the house), so getting a more affordable payment makes sense. Fannie and Freddie hold or guarantee about 40% of all mortgages outstanding. This plan seems fair since it applies to homeowners who would qualify for refinancing except for the value being down which was not their fault.
The lower payment plan is more controversial and probably not workable. Treasury will partner with lenders to reduce monthly payments. If lenders reduce interest (or principal) so a borrower would have a mortgage payment-to-income ratio of 38%, then Treasury will match the lender to reduce the ratio further to 31%. Treasury will also “reward” borrowers a $1,000 for every year they make these new lower payments. This is what got Rick Santelli of CNBC riled up. His point is well taken. This part of the plan helps someone who took out a high interest rate loan – most likely a subprime loan. Those borrowers who acted responsibly will get no help and will pay taxes to help those who were not as sensible. It is unclear how many homeowners the lower payment plan will actually help. It is limited to home owners with a conventional mortgage (generally less than $417,000). It is a voluntary program – lenders do not have to participate. It will be very complicated to address by mortgage servicers since nearly 70% of all home mortgages are held in pools and sold as securities or collateralized loan obligations.
One of the more damaging aspects of this plan is judicial modifications or “mortgage cram-downs.” This will have to passed by Congress but the House version has unlimited judicial discretion where bankruptcy judges can change the provisions of mortgages and develop “affordable” plans – 100 year mortgages could be an outcome. There are over 400 bankruptcy judges and the potential for 400 different guidelines for modifications. Not only would it be an administrative nightmare but will significantly discourage any lender from making new loans or, at least, charge a significantly higher rate.I think I'll go spend some time over at Angry Renter...
Fannie Mae and Freddie Mac have affected mortgage rates for years. This is why banks and thrifts hold only about a quarter of all mortgages. Fannie and Freddie have had access to lower cost funds because of implied or actual Treasury guaranties. They have been much more leveraged, which means less capital required. They obviously have mispriced credit and (I won’t go into the details now) have mispriced the ability to refinance. So mortgages are not profitable assets for banks to own. This plan will further this rate difference and shift more of the market to the government and away from banks.