Chairman Barney Frank (D-MA) of the House Financial Services
Committee has proposed H.R. 5830, which would use the Federal
Housing Administration (FHA) to refinance at-risk mortgages at a
lower interest rate in return for a cash fee. Under the
legislation, lenders that chose to take part in the voluntary
program would agree to receive 85 percent of the current assessed
value of the house, while the borrower would receive a refinanced
loan equal to 90 percent of that new assessed value. Refinanced
loans would be 100 percent guaranteed by the FHA, and the new
lender would have no further credit exposure if the borrower
subsequently defaulted. If the homeowner subsequently walked away
from the new loan, and if the FHA lacked the resources to back the
loan, then the taxpayers would cover any losses.
H.R. 5830 is a revised version of an earlier proposal by both
Chairman Frank and Chairman Christopher Dodd (D-CT) of the Senate
Banking Committee. While it is an improvement in some ways over the
original plan, it still has many problems that make it the wrong
way to deal with housing finance problems.
The proposal has many shortcomings. Specifically:
- It is essentially a government buyout of problem mortgages
disguised as a refinancing plan.
- It is an extremely bad precedent, as lenders will quickly
request that this guarantee be made available for all loans to
borrowers with poor credit histories or lower incomes. Until now,
the mortgage market has operated under free-market principles with
a moderate level of government regulation, but this program would
be a step toward government micromanagement. As a significant
number of the loans now facing problems were made by irresponsible
mortgage brokers using inaccurate and even false data, it would
also signal that there are no real consequences for poor lending or
- Many of these refinanced mortgages will still be likely to
default. The Congressional Budget Office (CBO) estimates that fully
one-third of refinanced mortgages under H.R. 5830 will subsequently
default. Historically, the risk of default is best measured by the
size of a down payment. The smaller it is, the more likely that the
borrower will walk away from the loan. While H.R. 5830 essentially
gives owners of refinanced homes an amount equal to 10 percent of
the current value of the house, this is a gift from the taxpayers,
and the homeowner has none of his or her own savings at risk.
Experience with similar "gift equity" programs already causing
problems for the FHA shows that these loans have a default rate
that is two to three times that of loans where the borrower has
made a cash down payment.
- The plan would reward two different groups of homeowners: those
who took out a speculative loan they never had a chance of repaying
in hopes of flipping the house in a rising market and those who
fell into trouble through no fault of their own. Unfortunately, it
is not always possible to distinguish borrowers by their
intentions. But in providing relief, especially relief to
homeowners/speculators, this bill sends a message that it is
acceptable to renege on an obligation because a government buyout
will cut your losses. The CBO estimates that, on average, each of
the borrowers will receive a subsidy from the government equal to
- Even if legislation were passed tomorrow, it is not possible to
implement this plan rapidly. The FHA says that it does not
currently have the people necessary to implement such a plan. It
will take subsequent legislation to appropriate the funds needed to
hire the appropriate additional federal work force, time to hire
them, and more time yet to train them. In addition, mortgages must
be refinanced individually. It will take a great deal of time to
refinance the 1 million-2 million loans that supporters say could
benefit. While supporters talk of refinancing loans in bulk, this
is not possible under current laws or industry practice.
- Closing costs for such refinancing can be expensive and are
regulated by state laws. Distressed borrowers may not have the
money available to pay them, and if the FHA covers the cost either
directly or indirectly, either costs will climb or the number of
potential beneficiaries will be reduced. Moreover, doing so would
also be unfair to the responsible borrowers who refinance their
- The estimate for the number of homeowners who would be helped
by H.R. 5830 continues to drop. First, supporters claimed that
about 2 million homeowners would have loans refinanced. Since then,
that number has steadily dropped, and now the CBO says that only
500,000 loans worth about $85 billion would be refinanced over the
next four years.
- Borrowers with legitimate problems are already being assisted
by the voluntary Hope Now program, which is in place and operating.
In the first quarter of 2008 alone, the Hope Now program assisted
over 500,000 homeowners--the same number that the CBO says H.R.
5830 will assist over the next four years. The program is certain
to help even more homeowners than H.R. 5830 in coming quarters
because, unlike H.R. 5830, it is up and running. H.R. 5830 merely
duplicates the existing private program at a cost of billions of
dollars and transfers all risk of default to the taxpayers.
- H.R. 5830 will not stop foreclosures, even for many who would
otherwise qualify. During the time it will take to put the program
in place, mortgage servicers will be legally bound to follow the
terms of the existing contract in case the refinancing falls
through, including taking steps toward foreclosure. Further, as the
CBO points out, many lenders will refuse to take part because it
would require them to take heavy losses in order to participate.
Other lenders who hold second mortgages on the same property could
also block refinancings.
The continued pressure on Congress to "do something" about the
large number of mortgages that are either in default or at risk of
defaulting once their interest rates rise to market levels is
extremely intense. Unfortunately, the Frank-Dodd H.R. 5830 really
won't do anything to solve the problem.
What has worked to date is Hope Now, a voluntary, private-sector
plan that allows homeowners who have the ability to pay a
lower-cost loan to refinance their mortgages. Hope Now has assisted
almost 1.4 million homeowners without major government
intervention. Rather than pressing for massive new programs,
legislators should allow one with proven results to do its
David C. John is Senior
Research Fellow in Retirement Security and Financial Institutions
in the Thomas A. Roe Institute for Economic Policy Studies at The