Refi Madness: The Heat is Frying your Brain (Redux)

It is a very hot August and the heat seems to be getting to people on Wall Street. In Washington the greater heat stems from fears about the impact of the economy and housing on the mid-term elections. As a result, Wall Street is expecting a big “surprise” in the form of a massive GSE refinancing plan, an unbridled expansion of the unsuccessful HARP program.

Don’t hold your breath.

Ongoing rumors of a streamlined GSE induced refi wave began last week with notes from Morgan Stanley and Bank of America. Folks at these firms proposed that borrowers could benefit, resulting in increased consumer spending, if only the GSE’s initiated a streamlined and broad program to allow those of their mortgagees who are current on their mortgages to instantly refinance from their higher rate mortgages to current market rates.

The argument is, since the GSEs own the credit risk anyway, they should change the refinancing requirements and lower or eliminate appraisal requirements and LTV requirements for refinancing. Doing so would, it is suggested, lower the burden on borrower cash flows, as they would benefit by lowering their rates by about 150bp. The pitch was ‘it would be a costless plan with real benefits’. Nice theory, too bad it doesn’t work and isn’t possible.

Beside the small consumer stimulus there could be another argued benefit to such a plan. By increasing the ability of borrowers to pay their primary mortgage, the plan would appear to help Treasury’s ongoing process of creating disparate benefits to second lien holders.

There are several and significant problems with this plan:

– As a result of another prepayment-shock and the inability to model future prepayment shocks, investors would become even more unwilling to invest in MBS gong forward, or would begin to demand higher yields going forward; unwilling to invest in MBS going forward, or would begin to demand higher yields going forward;

– The interest rate risk that this would cause, as banks and the GSEs themselves all had to re-hedge their books at the same time, could precipitate a systemic risk issue;

– The prepayments would cost investors more than half a trillion in lost interest income;

– Such a “streamlined” refi program would cost state and municipalities billions of dollars in transfer fees that they would normally be able to charge on a refinancing;

– Keeping borrowers in their homes with rate reductions could be argued to be consistent with maximizing value under conservatorship. A streamlined and across the board refi program that treats all borrower LTVs and other features the same would appear to violate the conservatorship;

– The GSEs, according to their trust agreements, are prohibited from soliciting prepayments. If they were in receivership these agreements could be abrogated but they would still have to pay value on the contracts; and

– Servicer’s could solicit borrowers to prepay on the program but it would be a nightmare to operationalize and oversee such a massive program.

We have heard absolutely no serious discussion of this hare-brained idea in regulator or policy circles. While we do not expect the GSE rumor to prove correct that doesn’t mean the situation is static.

We will soon see the implementation of their previously announced HAMP and FHA short-refinancing programs. Even though initial HAMP results will not be reported until you can expect the Administration to “sell it hard” and play it up. The Principal Reduction Alternative in the “new” HAMP is voluntary1 but does state “participating 2MP servicers must forgive an amount of principal on 2nd liens in equal proportion to the amount forgiven on the first lien loan by the 1st lien servicer.”2 The fact that about half of all second liens and HELOCS are owned by the same banks that service the firsts on behalf of mortgage investors, and that those banks continue to hold the value of their seconds at prices that far exceed a fair mark, you can expect that this voluntary approach will be generally left unused.

Also, as early discussions on the FHA short-refi program were happening, there were questions of whether the GSEs would be involved. At the time we were hearing the GSEs were developing their own short-refinancing program. It remains unclear am what that would be but it is important to remember that the Federal Housing Finance Agency is acting as “conservator” to the GSEs. “The FHFA, as Conservator, may take all actions necessary and appropriate to (1) put the Company in a sound and solvent condition and (2) carry on the Company’s business and preserve and conserve the assets and property of the Company.” This suggests any short refi program would have to be narrow, as drawing it too broadly would cause the dissipation of assets from the conservatorship.

Those who would suggest this view of the conservatorship ignores that politics will trump legality in a difficult mid-term election cycle should remember that politics are a two way street and the Republicans would make hay with any significant violation of the conservatorship. It is in large measure the public’s weariness from random interventions into market function and ineffective programs which continue to advantage banks ahead of market participants and the real economy that have caused so much unhappiness with this Administration. A new and massive program that crams losses onto investors rather than addressing fundamental problem3 will not be well received.


Morgan Stanley: More Irresponsible Mortgage Lending, Please (July 28, 2010)



1 Note: The Special Inspector General for TARP, in his Quarterly Report to Congress states “PRA does not require servicers to forgive principal, even when doing so is deemed to offer greater financial benefit to the investor.”



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