An August Surprise For Housing?

Rumors are swirling that Obama will soon announce a principal-reduction initiative that would reduce mortgage debt for millions of  underwater homeowners. The story quickly went viral. Though the administration just confirmed the story is false, they are no-doubt scrambling to create some positive economic momentum heading into this November’s election.

First, the initial story via James Pethokoukis at Reuters:

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.

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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.

CR quickly called the story nonsense:

The blog post includes the poorly considered proposal from Morgan Stanley (that Tom Lawler responded to last week), and an excerpt from a July 16th Goldman Sachs research note that suggested “while there are ways in which the GSEs could provide support through policy, the effects on the broader economy would ultimately be fairly modest.”

Not exactly foretelling a “gigantic bailout”.

This nonsense is part of the silly season. Sure, some small changes could be made to Fannie and Freddie, but nothing like this post would suggest.

Not. Gonna. Happen.

Tyler Durden added:

if the rumor is true, the US taxpayers are about to subsidze over three quarters of a trillion in underwater equity (and bail out banks on the hook for over $2 trillion in impaired debt). There is no indication if the “instarefi” plan contemplated by Morgan Stanley and Merrill Lynch has been scrapped, but what is certain is that the two plans target two very distinct beneficiary groups: the former plan would mostly benefit middle and upper class mortgage holders who are likely preoccupied to bother with a 200-300 bps refi differential. The loan absolution plan, on the other hand, focuses squarely on the poorest 15 million US households of society. While it is distinctly possible that Obama, in all his economic lunacy, will pass both plans, his advisors have likely done the math and are now convinced which way the negative IRR to the taxpayer will be greater: that is certainly the plan that will be undertaken.

Market Ticker chimed in:

Uh huh.  Ok, let’s do a bit of thought on this.

First, 30% of the people in this country own their homes outright – no mortgage at all.  Of the remaining homes, about 30% are underwater.

So that’s 30% of 70%, or 21% of the total.

Now subtract all those who are not paying (maybe half of the underwater loans?) and you get somewhere around 10% – perhaps 15% at best – of the homeowners.

The other 85% won’t get “helped”.

Politically, this is suicidal.  It is especially suicidal among older voters (who vote more often!) as they’re more likely to have paid-off houses (or houses where they’ve been paying for a decade or more) than younger people.  This wouldn’t help Obama and the Democrats, it would utterly decimate them both come November.  Count on it.

Second, this would trash the hedging that is currently used in the mortgage security market.  That market would become dramatically overhedged, which could lead to an instantaneous and nasty dislocation.

Third, it won’t do anything for prices – in fact, it likely would push them downward, as it would permit “clearing” of homes that currently can’t be sold (and thus do not establish a market-price mark) due to being underwater.

Finally, where ‘ya gonna get the $800 billion?  We’re already into the bond market for $926 billion this year.  Treasury comes to market with that much again (roughly) and we might see some “interesting” effects in the Treasury market as well – none of them good either.

I don’t buy it.

From The Atlantic:

First, this could really happen. The Treasury has unlimited discretion to plow as much money as it pleases into Fannie and Freddie. So adding several hundred billion dollars to the $150 billion already provided through their bailout would be as easy as the stroke of a pen. Moreover, the government’s other foreclosure efforts, particularly the HAMP program, have had lackluster success. This would provide the principal reductions that many progressives have been calling for to make for more effective modifications — but even for those who aren’t in danger of foreclosure.

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Make no mistake: this is a very controvresial idea. Not only would it mostly benefit a specific subset of Americans, but it would also be done in such a way to tiptoe around the usual political process. Of course, considering that it is virtually impossible to pass any more stimulus at this point, this might be the administration’s last chance to try to revive the economy before midterm elections. It would be hard to interpret something this drastic as anything other than an act of desperation, however, given all drawbacks of the plan and anger it would create.

Then came an official denial:

“The administration is not considering a change in policy in this area,” said Treasury spokesman Andrew Williams.

Followed by a retort from James Pethokoukis:

The Treasury Department has officially denied it is planning the mother of all mortgage bailouts. And I have no reason to doubt Team Geithner. But of course that assumes that the whole idea was not being cooked up by the White House political team (Rahm and Ax) and not the good folks at Treasury. During the financial reform debate, banking lobbyists continually complained that Geither and Summers had been usurped by R&A in policymaking. And I have gotten zero pushback from the WH. Food for thought. More to come.

In other words, the idea came from politicians, not economists. Given that the incumbents aren’t looking so good going into an election, I suppose just about anything is possible.

We’ll keep you posted.