The initial American Recovery and Reinvestment Act of 2009 provided an $8,000 credit for first-time homebuyers as I had discussed in my post here. The program was supposed to end on November 30, 2009.  However, the woes that befell our economy and the housing industry in particular have shown no signs of going away easily. In response, Congress passed the Worker Homeownership and Business Assistance Act of 2009 which extends the first time home buyer credit program to April 30, 2010. In a surprising move, Congress extended a credit of up to $6,500 to even existing homeowners for buying a house.

To take advantage of the program, you have to sign a contract to buy the house by April 30, 2010 and close the deal by June 30, 2010. The repeat buyers have to have the new house as their principal residence, and should have stayed in the same principal residence for five consecutive years during the last eight years.  The act also increases income limits for taxpayers eligible to take the credit under the program.  The tax credits for purchases after November 6, 2009 are phased out for a modified adjusted gross income (MAGI) between $125,000 and $145,000 for single filers and between $225,000 and $245,000 for joint filers. The existing tax credits for purchases on or before Nov. 6, 2009 phase out at a MAGI of $75,000 to $95,000 for single filers and $150,000 to $170,000 for joint filers.

The complete text of the Worker, Homeownership, and Business Assistance Act of 2009 is available here.  The Internal Revenue Service has information on the home buyer tax credit on its website here and here.  The National Association of Home Builders also has information on the home buyer tax credits on this website.  Together, these should answer most questions you might have on the credit.

One thing to note is that if you sell your existing home, the profit on the sale might be counted towards income in determining eligibility for the tax credit.  However, only the profits beyond the historic exclusions (from taxes) of $250,000 for single filers and $500,000 for joint filers are counted towards income.  This LA Times article explains this in more detail.

Missed the boat?

Yeah, we missed the boat on the substantial $6,500 credit. But actually it’s more like the boat missed us.  We crossed the river without a boat like everyone in our shoes was supposed to.  Only later, the powers-that-be decided to send a boat to provide incentives to cross the river. We had no idea that there was going to be a tax credit for existing homeowners. If we knew for sure, we would have waited.

But, no big deal. It was still a good time to buy a house.  We bought the house at an almost 40% discount from the price the previous owner paid for it almost 5 years ago.

If you are considering buying a house, you should definitely consider buying within the window providing for the tax credit, especially because it is a refundable tax credit.  In other words, you get paid the complete credit even if you owe no taxes or less taxes than the credit. The downside risk of substantial price decline seems minimal at this time because the house prices have stabilized or even crept up in some markets.

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The CARS Act provides consumers incentives to replace an old gas guzzler with a new fuel-efficient vehicle.  If you have a less than 25 years old car, and it was rated for less than 18 mpg when new, you can get a government voucher for $3,500 or $4,500 from the dealer towards the purchase of a new more fuel-efficient vehicle.  The $3,500 voucher applies when the mileage improvement is between 4 and 10 mpg.  The $4,500 voucher applies when the mileage improvement is more than 10 mpg.

Source: http://www.flickr.com/photos/mccaffry/3020832485/

The trade-in vehicle must be drivable, and be continuously insured and registered to the same owner for the full year preceding the trade-in to qualify for the payment.  So a working clunker is okay, but a dead clunker salvaged from the junkyard to claim the voucher will not work.  The dealer will be required to certify that the trade-in vehicle has been scrapped effectively taking it out of circulation.  The program is only available from July 1 through November 1.  However, National Highway Traffic Safety Administration (NHTSA) responsible for administering the program recommends waiting until July 23 when it will come out with the final rules and regulations for the program it calls the Car Allowance Rebate System (CARS).  The Act appropriates $1 billion for the program, which translates into approximately 250,000 vouchers or new car sales.

The details of the program are available here on this webpage.  The fuel economy ratings for the trade-in vehicle brands is available on this website.  There is a nice table showing the eligibility requirements for different vehicles here on this website.  Please note however that this table does not explicitly show the maximum allowable fuel efficiency for the trade-in vehicle to qualify.  For example, purchasing a new passenger car with 31 mpg with a trade-in passenger car with 20 mpg would not qualify for the program even though the mileage improvement is more than 10 mpg because the maximum allowable mpg for the trade-in vehicle is 18 mpg.

Source: http://www.cashforclunkers.org/edmunds-dealix-webinar-recap.html

Is the Program a Blockbuster in Waiting?

The program has its obvious flaws.  Those who keep and drive clunkers generally do not do it out of choice.  A new car costs anywhere from $15,000 to $20,000 at the least.  It also has higher insurance and registration costs.  Many clunker owners would not have the cash to pay for all the costs of a new car or the financial wherewithal to qualify for a new car loan, especially in this economy.  Those who could afford to pay for a new car with cash or financing, generally would not be the clunker owner/driver.  It is, therefore, unlikely that we are looking at a blockbuster program ahead of us.

Is it Worth It?

Just assume, hypothetically, that you are in good financial standing and you have a gas guzzler that you have been wanting to get rid of for a long time.  And, lo and behold, the government has just come out with the cash for clunkers program with its potential benefits to the consumer, the environment, and the auto manufacturer.  Who is it good for?

Assuming that you drive 15,000 miles per year and you go from a 18 mpg clunker to a 28 mpg shiny new fuel-efficient car, you will go from burning about 833 gallons of fuel per year to about 536 gallons of fuel per year.  That is a saving of about 297 gallons of fuel per year.  Assuming the average price of gas to be $3 per gallon, the cost savings are about $891 per year.  These savings continue for the life of the new vehicle.  However, for a realistic comparison, you should only count the savings for the period your clunker would have continued to operate without dying.

You also have to weigh in the registration, insurance, and repair and maintenance costs.  The registration and insurance costs for the new vehicle would definitely be much higher than those for the clunker.  The repair and maintenance costs for the new vehicle could be low in the initial years compared with those for the clunker car.  The financing costs could also be significantly higher for the new car assuming you finance your purchase, and the clunker was paid for.  The sales tax on the purchase of the new car would also be substantially higher.  However, fortunately the sales tax on the car is going to be tax-deductible this year.

In effect, you have to compare the total costs of ownership including registration, insurance, operating, and repair and maintenance costs for the clunker and the new car including the voucher benefit, for the period you were going to keep the clunker.  It is unlikely that purely financially you will come out ahead with the new car option.  However, if your clunker is only worth a couple of thousand dollars in trade-in value, and is ready to die any day now, it may be advantageous to use the cash for clunkers program to offset your total costs by the voucher amount minus the original trade-in value.

Because the trade-in car is going to be scrapped, you cannot get any additional trade-in value for it other than the voucher.  If the car’s trade-in value is more than $4,500, it doesn’t make sense to use the CARS program to get just $4,500.  This website here lists all the cars with a trade-in value of less than $4,500 that could qualify for the CARS program.  If your car is one of those in the list, you could use it as a trade-in for the CARS program.  Of course, you should ascertain the real trade-in value of your car at your local dealer. If the trade-in value of the car is just about $4,500, it makes sense to use the program and take the clunker out of circulation for the sake of the environment.  However, the lower the value of your trade-in is, the more there is financial benefit in addition to the environmental benefit in using the program.

There is a benefit to the environment in reduced greenhouse gas emissions from tailpipes when a fuel-efficient car replaces a gas guzzling clunker.  However, to really make it good for the environment, the CARS program should not have required the replacement vehicle to be a brand-new vehicle.  Clunker owners would be more likely to use the program if the costs were not so onerous.

As far as the auto manufacturers go, any boost to new car sales from the cash for clunkers program would be highly welcomed by them given the ongoing decline in sales experienced by auto manufacturers across the board.  It is unlikely in my opinion that the program will provide a significant and substantial relief to the auto manufacturers.

Total Cost of Automobile Ownership

If you are in the market for a new car to take advantage of the cash for clunkers program or otherwise, it is a good idea to compare the total cost of ownership between the different car options to chose the best option over all.  A car that costs cheapest out the dealer door, may not be the cheapest car when you add up all the costs to own and operate the car.

Edmunds.com has a good explanation of cost of ownership here at this webpage.  You can specify the details of your car including make, model, and year etc. on this webpage to get an estimate of the cost of ownership.  You can even compare similar models for total cost of ownership.  For example, even though the 2009 Nissan Ultima costs more at $22,755 than the 2009 Toyota Camry at $21,915, the total cost of ownership for the Ultima is $0.54 a mile compared to $0.58 a mile for the Camry.  Over the five-year, 75,000 mile period, the Ultima is estimated to be cheaper than Camry by almost $2,500.

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She originally bought her condominium for $77,500 in 1997. As her condominium appreciated in value, she refinanced a couple of times and took out a home equity loan adding to her mortgage balance. Cashing out of her condominium as the condominium price appreciated during the inflating period of the housing bubble allowed her to retire some credit card debt, and pay for a new car and a new roof on the house.

After losing her job, she struggled hard to keep making her house payments for a while, but she pulled it off somehow. Finally, when it was clear she wouldn’t be able to do that anymore, she called the bank for a loan modification.

Even though she was eligible for it, the bank turned her down. The bank very cleverly asked her to hand over $18,000 including $5,000 in fees after which the bank would be able to cut down her monthly payment from $1046 to $967 or by $79 per month.

It appears the bank was taking the extra money, putting a large part of it into paying down the balance to bring loan to value within the 105% requirement of the Making Home Affordable Refinance Program, and then offering a refinance to Ms. Ulery. Of course, the bank’s solution doesn’t help or solve Ms. Ulery’s looming delinquency problem because the new mortgage payment would still not be affordable for her even if she could somehow find $18,000.

This example is pretty typical of how rational decisions are made by lenders and mortgage servicers. Ms. Ulery is eligible for loan modification as per Treasury’s guidelines for the loan modification program, but of course, the lender/mortgage servicer is NOT REQUIRED to offer it to her.

Offering loan modification to her would mean taking an immediate financial hit for the lender, which they could delay or at best avoid altogether. Ms. Ulery has been regular with her mortgage payments so far. She seems to want to keep her house and credit score, and might find a way to keep making those payments. If she were to stop making her mortgage payments and foreclose, then the bank would take a hit. But obviously, she is not at that stage yet.

That brings up a discussion of Ms. Ulery’s attempts to stay current on her mortgage and seek relief. The Making Home Affordable Program can help her some, but only when the lender/mortgage servicer finds helping her to be a better option (less costly) than not helping her and allowing her to foreclose on the house. It would seem the rational thing for Ms. Ulery would be to move toward foreclosing, because that could be an incentive for the lender to work with her.

It is unfortunate that the two parties seem to have to game their response to make the system work in their short and long-term benefit.

Ms. Ulery should also look into the Hope for Homeowners (H4H) Program. If she has a good credit history to qualify for a FHA mortgage, she could have her principal balance reduced to 96.5% of her home value. She will have to pay mortgage insurance, but at least in theory she could have a lower payment schedule. In practice however, looking at the history of H4H, the likelihood of her actually getting a H4H refinance are not very high.

What do you think? Should she stop paying her mortgage and then try a loan modification with the bank?

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Source: www.ehow.com

The Obama administration has been coming out with a slew of programs to stop the ongoing foreclosure hemorrhage in housing industry. Treasury came out with the Making Home Affordable Refinance and Modification programs earlier to help defaulting homeowners. Next came the Second Lien Program. Treasury also modified the Hope for Homeowners (H4H) program. Since then, Treasury has come out with the Foreclosure Alternatives and the Home Price Decline Protection Incentives Programs.

Foreclosure Alternatives Program

The Foreclosure Alternatives Program provides incentives to a homeowner and the mortgage servicer to pursue short sales of homes or deeds in lieu of foreclosure. Troubled Borrowers meeting the minimum eligibility requirements for a Home Affordable modification but unable to qualify for a loan modification will receive up to $1,500 to help with relocation expenses when they agree to a short sale or deed-in-lieu of foreclosure. Mortgage servicers will earn up to $1,000 for successfully completing the short sale or deed-in-lieu.

The Foreclosure Alternatives Program provides for a simplified and streamlined process, time frames, and standard documentation for short sale and deed-in-lieu. More details on the program are available here in this webpage on Treasury’s website.

Home Price Decline Protection Incentives Program

In neighborhoods where home prices are continuing to decline presenting a disincentive to the lender to do a loan modification, the Home Price Decline Protection Incentives Program provides additional cash incentives for two years after loan modification with the amount of the incentive linked to the decline in local housing prices. More details on the program are available here in this webpage on Treasury’s website.

Helping Families Save Their Homes Act of 2009

Last week on Wednesday, President Obama signed into law the Helping Families Save Their Homes Act of 2009. The Act modifies the Hope for Homeowners Program by reducing fees and providing greater incentives to mortgage servicers for loan modification. It also makes the underwriting requirements more consistent with standard FHA practices.

The Act also provides a safe harbor from liability to mortgage servicers performing a loan modification consistent with Treasury’s programs or utilizing Hope for Homeowners. Investors lobbied heavily against the provision claiming sanctity of contract law but lost in the end. Congress had earlier rejected mortgage cramdown, that is, mortgage modification by a bankruptcy judge. The safe harbor provision has been presented in as an alternative to bankruptcy cramdown.

The Impact on Foreclosures

Is the full force of the federal government as reflected in these various initiatives going to root out the drumbeat of foreclosures? I think these programs only tinker at the edges of the problem. In the end, these programs provide incentives to avoid foreclosures rather than require lenders and servicers to not foreclose. The size of the incentive is not tied to the size of the mortgage, and thus, can be relatively minor in expensive markets. Lenders and servicers have generally appeared to have chosen to not realize a quick loss on their books by loan modification or refinancing. Or maybe, they are holding out for the government to come out with even better incentives if things stay bad.

There is some hope that with the threat of investor lawsuits gone, some mortgage servicers may be more inclined to modify a loan than before. Of course, it will probably only work when the mortgage servicer is not the original lender. The safe harbor provision provides the only worthwhile ray of hope in substantially impacting ongoing drumbeat of foreclosures.

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Second Lien Program

As I had discussed in my earlier post here, the Home Affordable Modification Program reduces mortgage payments on the primary debt for homeowners close to defaulting or foreclosing.  However, the Home Affordable Modification Program did not automatically modify the payments on any secondary lien on the house.

Source - http://www.flickr.com/photos/respres/2539334956/

With the Second Lien Program, payments on the second mortgage will be sharply reduced by participating mortgage lenders according to a set formula for any customers who have modified their first mortgage.  For borrowers paying principal and interest on the second mortgage, the interest rate would be lowered to just 1%.  For borrowers paying interest only, the interest rate would be lowered to 2%.

If any part of loan balance was forgiven by the lender on the first mortgage, the same proportion of the second mortgage would be forgiven.  The second lien can also be extinguished for a lump-sum payment according to a pre-set formula determined by Treasury.  Basically for second loans due payment for more than 180 days, the lender will be paid three cents on the dollar for extinguishment.  For loans past due less than 180 days, the lender would be paid anywhere from four to twelve cents on the dollar for extinguishment depending upon loan to value (LTV) and debt to income (DTI) ratios.

Besides sharing the cost of reducing monthly payments with the lender, Treasury is also offering lenders $500 cash incentive upfront and $250 a year for three years if the buyer maintains payments after loan modification.

Hope for Homeowners Program

The Treasury is also trying to revive its beleaguered Hope for Homeowners Program (H4H) by offering new incentive payments for lenders and requiring mortgage servicers participating in Home Affordable Modification program to evaluate if the borrower could qualify for H4H.  Treasury will pay lenders $2,500 at the time of H4H refinance and $1,000 a year for up to three years if the borrower continues to make mortgage payments on time.

H4H refinance potentially offers a homeowner facing foreclosure a way to reduce loan balance to 96.5% of the current home value.  The remaining loan balance will be written off by the lender as a loss.  However, the borrower must be able to qualify for an FHA (Federal Housing Administration) loan, has to pay mortgage insurance premiums, and has to share any gains from selling a home in future at an appreciated price with the government.

The Impact on Foreclosures

So, is it all wonderful?  Will these new initiatives be the last nail on the coffin burying homeowner defaults and foreclosures?  Well, not quite.

Treasury itself says that the Second Lien Program will help reduce mortgage payments for one to one and a half million borrowers out of the three to four million homeowners estimated to be helped by the original Home Affordable Modification program.  It is not expected to expand the pool of borrowers expected to be helped any more than the primary mortgage modification program.  It will streamline the process in that the uncertainty in dealing with the second mortgage on a house will be eliminated for those qualifying for the Home Affordable Modification program.

The H4H program was launched last year amid much fanfare, and has been a miserable failure.  It has helped a grand total of one homeowner avoid foreclosure so far.  The lenders have opted to take the loss at foreclosure rather than take a loss by cutting some of the principal that borrowers owe.

With the new announcement, lenders could pocket up to $5,500 for modifying a loan balance down to 96.5% of the current house value.  However, the H4H program does not require a lender to modify the loan balance.  It is left to the lender’s fiscal interest/judgment to decide whether to modify the loan balance or not.

Simple math suggests that $5,500 is not enough of an incentive when the house value has dropped precipitously in expensive markets like California, Nevada and Florida.  The new program might nudge some lenders to cut down the loan balance for some homeowners facing foreclosure, but it is not likely to help the vast majority of homeowners facing foreclosure.

The Obama administration was also trying to get legislation passed in Congress allowing bankruptcy judges to alter loan terms and shield mortgage firms from investor lawsuits when they ease loan terms.  The House passed the legislation, but the Senate left out the provision to allow bankruptcy judges to modify the loan balance.

With the potential threat of mortgage reduction by a judge gone, there is little likelihood of a lender cutting down the loan balance for a foreclosing homeowner.  Foreclosures, meanwhile, continue as the economy and unemployment go from bad to worse.  At least 4 million homeowners are estimated to face foreclosure this year compared to about 2.2 million homeowners in 2008.

So, all in all, Treasury’s new Second Lien and Hope for Homeowners Programs are unlikely to add new foreclosing homeowners to the pool of those likely to be helped by existing programs.  The programs are unlikely to substantially stop the continuing drum beat of additional foreclosures.

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Historic Mortgage Interest Rates

Figures below show the historic conventional conforming 30-Year fixed mortgage rates from 1971 through 2009, and 1993 through 2009.  Mortgage interest rates averaged the highest at over 18.5% in 1981 (along with high inflation).  Mortgage rates rarely went above 7% after 2002, and averaged over 6.6% at their 2008 peak in July.

Thanks to the concerted efforts by the Federal Reserve and Treasury, mortgage interest rates have come down drastically since then.  For the week ending April 30, 2009, the average interest rate for 30 year fixed-rate mortgage was 4.78% with 0.7 points in fees.  This equaled the rate for the week of April 2, 2009, and is a historic low according to Freddie Mac’s survey going back to 1970.

Additional Fees

Fannie Mae and Freddie Mac have raised some of the fees charged to lenders when they buy or guarantee certain types of mortgages, most of which are going to be passed down to consumers.  It will impact both — mortgages for new purchases, and refinances of existing mortgages.

Fannie Mae has revised upwards its Loan-Level Price Adjustment (LLPA) Matrix effective April 1, 2009.  Depending on the borrower’s credit score and (mortgage) loan to (home) value ratio (LTV), the additional fees range from 0.25% to 3% of the loan.  Refinancing with a loan bigger than the principal balance on existing mortgage for a cash-out will add another 0.25% to 3% in fees.

For example, someone with a credit score of 660 and LTV of 85% would pay 2.5% in fees instead of 1.75% prior to April 1, for a 30-year fixed-rate mortgage.  Additional 2.5% fees would be tacked on for cash-out refinancing in such a case.

Condominium mortgages seem to have been hit the hardest.  Refinancing a condo loan might be affected by the presence of commercial tenants or investors in the entire condo project.  There is now a mandatory 0.75% fee on all condominium loans regardless of the borrower’s credit score, and other fees have been jacked up.  For example, someone with a credit score of 690 and LTV of 80% on a condominium with a 30 year fixed-rate mortgage with initial payments of interest only will now pay 3.25% in fees instead of 1.25% prior to April 1.

Some lenders are going further in imposing new restrictions.  For example, Wells Fargo now requires a minimum FICO credit score of 720 for loans with LTV greater than 80% instead of 620.  It has also reduced the maximum total debt-to-income ratio from 45% to 41%.

The cost of private mortgage insurance, or PMI, required when LTV is greater than 80%, is also going up for those with lower credit scores under the new “risk-based pricing” by mortgage insurance companies.

Appraisal Rule Changes

Under Fannie Mae and Freddie Mac’s new Home Valuation Code of Conduct, effective May 1, mortgage brokers can not order appraisals directly, and lenders can not select or communicate with appraisers.  Lenders must use third-party “appraisal management companies” to assign the job to appraisers in their networks.  If the appraisal comes lower, the loan may not go through.  As a consequence, borrowers will probably have to pay appraisal fees upfront whether the loan goes through or not.

Appraisers are also being required to include a “market condition” report providing statistical analyses of local sales and pricing trends.  It is expected to add to the cost of preparing an appraisal report, which is sure to be passed down to the borrower.

Each point in extra fees is equal to 1% of mortgage loan.  For an average $200,000 mortgage, each point in fees equals $2000.  An increase of three points in fees means additional fees of $6,000.  In the more expensive neighborhoods with higher home prices, the additional fees could amount to two to three times as much.

It would make sense to ask your lender or mortgage broker if your loan will be sold to or insured by Fannie Mae or Freddie Mac to see if you would be liable for these higher fees.  It could be worth a lot of money to compare  independently or with a mortgage broker, the interest rate and total fees charged on loans sold/insured by Fannie Mae/Freddie Mac as well as other lenders before selecting a loan package for your new home mortgage or refinance.

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As I had described, Treasury has a comprehensive self-assessment tool provided on this website to determine eligibility for the Making Home Affordable Refinance and Modification Programs.

Now, there is another option, thanks to Fair Isaac Company, the company that created and computes the FICO credit score significantly affecting the credit transactions for all consumers.  Fair Isaac has launched MortgageReliefOnline.com.

It is a free service designed to help you find out if you qualify for mortgage relief under the Government’s Making Home Affordable Program.  If you qualify, this site provides free access to HUD-approved certified professional counselors at Money Management International.  If you qualify for free mortgage counseling, Fair Isaac also gives applicants a free credit report and credit score.

To use the free service, you have to fill out a form on the web site.  A word of caution here — it is an educational web site.  It won’t actually refinance or modify your loan.  You will ultimately need to work with your mortgage servicer for loan refinancing or modification.

Lately, there has been a spate of complaints by homeowners trying to stave off foreclosures about delays and frustrations in dealing with lenders.  This site can help with determining eligibility for the Making Home Affordable Program.

Have you had to deal with your lender and/or mortgage servicer to refinance or modify your mortgage?  How satisfied have you been with your experience?  What did you learn that could help others going through the process, or help improve the process?

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He said, “As best we can tell, so far the programs are having the intended effect.”  He cited a drop in the 30-year fixed mortgage rates as an example.  It is true that the 30-year fixed mortgage rates have dropped dramatically to historically low levels.  But, can the same success be seen in other metrics signifying the credit crunch?  Has the credit crunch ended already?  Are the banks lending like before?

The TED and The LIBOR-OIS spreads are the commonly used metrics to test credit easing or lack of it.  In an earlier post here, I had gone into the definitions and characteristics of the two metrics.  In a nutshell, increasing TED and LIBOR-OIS spreads indicate that the banks are concerned about a higher risk of default on their loans.

TED Spread

The figure below shows TED spread for the five-year period ending on April 3, 2009.  It ended the day with a value of about 94 basis points from a peak of 464 basis points on October 10, 2008.  However, it trended much lower pre-credit crisis and averaged 36 basis points in 2006.

Source: http://www.bloomberg.com/apps/cbuilder?ticker1=.TEDSP%3AIND

LIBOR-OIS Spread

The figure below shows LIBOR-OIS spread for the five-year period ending on April 3, 2009.  It is around 100 basis points, about the same value it had shot up to in August/September 2007 at the onset of the credit crisis.  However, it is down from its peak value of over 350 basis points in October last year.  Historically, it was of the order of 10 basis points.

Source: http://www.bloomberg.com/apps/cbuilder?ticker1=.LOIS3%3AIND

Both the TED and the LIBOR-OIS spreads indicate considerable easing of the credit crunch from its worst.  However, the data indicate that the credit crunch is still alive and kicking.  Former Federal Reserve Chairman Alan Greenspan said in June, 2008 that the LIBOR-OIS spread would have to fall to 25 basis points for him to consider markets back to “normal.”

Banks still consider lending riskier, and are, therefore, not lending like before.  Historically low mortgage rates are welcome in that many existing homeowners might be able to refinance their mortgages to put a little extra cash in their pockets.

However, in the face of increasing unemployment, foreclosures, and a lack of consumer confidence, low mortgage rates alone are unlikely to spur a housing boom.  That will happen only when businesses encompassing all parts of the economy begin to move forward in tandem unfettered by credit crunch.  The economic engine cannot move forward efficiently until all the moving parts of the economic engine get a liberal dosage of its lubricant – credit.

Until the two spreads come down to their historic pre-credit crisis values, it would be wrong to assert that the credit crisis has eased.  What do you think?

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The prevailing theory for some time has been that once the toxic assets are off the banks balance sheets, banks would be lending again.  The credit squeeze will ease, and the economy will begin to recover.

In fact, Bush’s Treasury Secretary Paulson was supposed to do just that under the authority of the Troubled Asset Relief Program (TARP) passed by Congress.  However, Paulson changed course and pumped cash into banks instead of purchasing the toxic assets.  Paulson had cited two reasons for this change of course – speed and bang for the buck.

We apparently didn’t get any bang for the bucks he pumped into the banks because bank lending did not improve.  And time wise, Geithner took about two months to come out with a toxic asset purchase program, less than the time available to Paulson after Bush signed the Emergency Economic Stabilization Act of 2008 authorizing TARP on October 3, 2008.

Treasury in conjunction with the Federal Deposit Insurance Corporation, Federal Reserve, and private investors will generate $500 billion to $1 trillion in capital to purchase toxic legacy loans and securities on banks’ balance sheets.  It is estimated that these toxic legacy assets on the books may amount to as much as $2 trillion.

The Public-Private Investment Program includes two components – Legacy Loans, and Legacy Securities.

Legacy Loans Program

Legacy loans are the toxic real estate loans held directly on the books of the banks.  Under the Legacy Loans Program, the Legacy loans will be auctioned off to private bidders with matching funds by Treasury and loan guarantees by FDIC.

On any pool of loans, FDIC will provide a leverage of up to 6-to-1 debt to equity.  Of the total purchase price, the equity will be shared equally between the private investor and Treasury.  The debt would be provided for by loan guarantees by FDIC.

For example, suppose that FDIC has decided to leverage a pool of legacy loans at a 6-to-1 debt-to-equity ratio, and the purchase price is $84.  In this case, the private investor and Treasury will invest $6 each for a total $12 in equity with a $72 financing from FDIC.

Legacy Securities Program

Legacy securities are the toxic securities backed by loan portfolios held by banks and other financial institutions.  Under the Legacy Securities Program, Treasury will match dollar for dollar private capital raised for an investment fund to purchase legacy securities.  In addition, Treasury will loan to the investment fund an amount equal to up to two times the private capital raised for the fund.

The investment fund would be managed by the Fund Manager responsible for raising the private capital with the strategic long term goal of buy and hold.  As an example, a Fund Manager able to raise $100 of private capital will have access to $300-$400 for purchasing legacy securities off the books of financial institutions.

A Clever Plan

The Internet and the blogosphere are abuzz with commentaries and critiques of the Program.  To me, it appears to be a cleverly designed plan to price and remove the toxic assets from the financial institutions’ books.

I remember when Tim Geithner was under consideration for the Secretary’s job, he had thrown around the idea of bringing private capital into purchasing the toxic assets.  The current plan does that and has two desirable features.

It is a good plan for the taxpayer because the asset pricing is accomplished by private control rather than by the government hand with the inherent risk of overpaying.  The plan also provides incentives to private parties to come to the table by providing them leverage.

In the absence of such government provided leverage, it is doubtful if the private parties would have taken the huge risk of purchasing these toxic assets.  As a matter of fact, they have not done it so far.  The private investors still have the downside risk of losing their entire capital, but because of leverage their upside gains could be multiplied — a classic capitalist market play able to attract the best and the brightest minds.  If these investors make money, the taxpayers make money.

Creative minds are already very busy figuring out how to game the rescue plan.  Only the future will tell if the program was abused, or if it was managed in a way so as to minimize the abuses.

According to Paul Krugman, Economics Professor and Nobel Laureate, this is a failed effort in moving banks, at least some big banks, from the brink of insolvency to healthy lending.  He fears the prices would be distorted because of taxpayer subsidy.  Even then, he expects these toxic assets to fetch very little on the dollar.  Of course, he expects investors to make a tidy bundle of money on the back of taxpayer subsidy.  He has advocated nationalization of banks to get the banks solvent and lending again.

Nouriel Roubini, aka “Dr. Doom,” likes the market-based approach of the Treasury’s plan and believes it does not preclude nationalization at all.  He believes nationalization remains an option for the insolvent banks determined to be so by the Obama Administration’s stress test, especially given Tuesday’s Congressional testimony by the Federal Reserve chairman, Ben S. Bernanke, and Treasury Secretary Timothy F. Geithner.

The Treasury plan is basically betting on private money rushing into the newly solvent financial institutions sans the toxic assets.  I don’t see why it won’t be so once the toxic assets are off the books.  America, after all, is the favorite capital destination of the world.

PPIP and Personal Finance

Lastly, how does the Program affect personal finances?  Apart from providing macro benefits realized in improved credit flow and economy, PPIP also provides for a lucrative opportunity to profit as an investor in the Legacy Loan Program.  According to the Treasury’s web page here:

Private market equity investors (“Private Investors’) are expected to include but are not limited to financial institutions, individuals, insurance companies, mutual funds, publicly managed investment funds, pension funds, foreign investors with a headquarters in the United States, private equity funds, and hedge funds.

According to this article in New York Times, Goldman Sachs is trying to whip up investor interest in the government’s rescue plans.  And, BlackRock is looking into the practicalities of starting a mutual fund so everyday investors could buy into banks’ toxic assets.  Such plans, when they materialize, could be the vehicle for individual investors to profit from PPIP.

What do you think?

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Is the plan going to reduce foreclosures?  Is it going to help delinquent and solvent homeowners?  And, is it going to be good for the economy?

There are two main programs within the Making Home Affordable Program.  The Making Home Affordable Program includes the Making Home Affordable Refinance Program and the Making Home Affordable Modification Program.

Home Affordable Refinance Program

The Home Affordable Refinance Program is for those homeowners who have been paying their mortgages on time.  With the recent plunge in property values, many homeowners have been left with less than 20% equity in their homes (or, their (mortgage) loan to (house) value is more than 80%), and therefore, cannot refinance their mortgages to take advantage of the lower interest rates of today.

The Home Affordable Refinance Program enables homeowners with up to 105% loan to value on their mortgages to refinance them to lower their payments.

To be eligible for the Home Affordable Refinance Program, you must have a Fannie Mae or Freddie Mac loan.  In other words only conventional loans are eligible, not jumbo loans.  You can call your loan servicer to find out if your loan is a Fannie Mae or Freddie Mac loan.  You can also contact Fannie Mae by phone at 800-7FANNIE (8am to 8pm EST), or online here, and Freddie Mac by phone at 800-FREDDIE (8am to 8pm EST), or online here to find out if your loan is a Fannie Mae or Freddie Mac loan.

Of course, your income must be enough to make the new payments.  If you just lost your job, you would not qualify.

The Treasury Department estimates that up to about four to five million mortgage holders would be able to take advantage of the Refinance Program.

Home Affordable Modification Program

The Home Affordable Modification Program is for those homeowners who can no longer afford their monthly payments and are close to defaulting or foreclosing.

The Home Affordable Modification Program will provide eligible mortgage holders with affordable monthly mortgage payments for at least five years.

To qualify for the Home Affordable Modification Program, the monthly mortgage payment (PITI or principal, interest, taxes, and insurance) excluding the secondary mortgage on the house must be more than 31% of gross income.  However, if your total debt (including home mortgage and other debts) is more than 55% of gross income, you will need to sign an affidavit promising to undergo counseling with a counselor approved by the Department of Housing and Urban Development before the loan modification can take place.

The loan must be a conforming Fannie Mae or Freddie Mac loan, and must have been taken out before January 1, 2009.  Very importantly, to qualify for the Modification Program you must not have enough liquid assets ignoring any retirement assets to pay off your mortgage.  Lastly, the house must be your primary residence.

If you qualify on all counts for the Home Affordable Modification Program, the loan servicer will attempt to reduce your mortgage payment to no more than 31% of the gross income by first reducing the interest rate on the loan to as low as 2%, and then successively extending the term of the loan to 40 years and deferring the loan principal.  To encourage participation, servicers will get financial incentives, such as an upfront fee of $1,000 per modification.  The loan modification can be done only once before 2012 when the program ends.

The modified interest rate will stay fixed for five years.  After that it will go up by 1% every year to catch up to Freddie Mac Primary Mortgage Market survey rate at the time of the loan modification.

As added bonus, after making timely payments for three months, borrowers may have an opportunity to have their second mortgages, if any, forgiven.  Those who continue to make timely payments may also see their principal cut by up to $1000 a year for five years.

According to the Treasury Department, the Home Affordable Modification Program may help up to three to four million borrowers modify their loans.

Treasury has a comprehensive self-assessment tool provided on this website to determine eligibility for the Making Home Affordable Refinance and Modification Programs.

Other Options for Those Who do not Qualify for the Making Home Affordable Program

According to Treasury’s web page here, there are a number of other options if you do not qualify for a Making Home Affordable refinance or loan modification.

These options include:

• A forbearance agreement wherein you make reduced payments for a specific period of time after which you make regular payments as well as an additional amount to pay off the past-due amount.
• A repayment plan allowing you to schedule payments for the past-due amounts if you missed any payments.
• Special mortgage relief assistance for active duty military service members.

Treasury’s Homeowner Affordability and Stability Plan also includes funding for mortgage servicers to help you with preforeclosure or short sale and deed-in-lieu of foreclosure agreements to help avoid the impact of a foreclosure on your credit rating.

The administration is also working on legislation that would allow bankruptcy judges to alter loan terms.  It will also shield firms that ease loan terms from investor lawsuits.

Effectiveness and the Impact of the Program on Foreclosures and the Economy

In the frenzied years of housing bubble, many house purchases were financed with subprime loans with little or no down payments.  A greater than five percent decline in property values, which is the prevailing norm, will make such a mortgage ineligible for the refinance program.

It is estimated that about 20 percent of the country’s 50 million mortgage holders owe more than 105 percent of their house’s value, and therefore, will not qualify for the refinance program.

The refinance program will most likely exclude areas with the biggest plunge in real estate prices.  For example, if you bought your house at the peak with a 10% down payment, your loan to value was 90%.  Now, a couple of years later, suppose your property value has fallen 25% from the peak, which is a fairly common scenario.  The loan to value for your house right now is then, about 90/75 or 120%.  A homeowner in such a situation would be ineligible to take advantage of the Refinance Program.

Basically, the Home Affordable Refinance Program puts some extra cash into a solvent homeowner’s pocket by reducing their mortgage bills.  It is unlikely to help homeowners who had put little down at the time of purchase or cashed out their equity near the peak of the housing bubble.  It will provide some fillip to the economy by increased disposable income and spending by the consumer.  However, the target group forms only a small part of the total American consumer population.

Treasury estimates that with the average house in the U.S. valued around $200,000, the average homeowner could see his or her home value stabilized against declines in price by as much as $6,000 or 3% relative to what it would otherwise be absent the Home Affordable Modification program.

However, with the restrictions on the loan amounts and owner occupancy coupled with the steep decline in property values, the program will likely not be effective in stabilizing home prices in key markets such as California, Nevada and Florida.

So, all in all, the Home Affordable Refinance Program will put extra money into the pockets of some solvent mortgage holders, and help a little with the economic recovery in the country.  The Home Affordable Modification Program will help some delinquent or nearly delinquent mortgage holders avoid foreclosure.  It will help a little in arresting home price decline and the economic recovery in some geographic locations in the country.

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