Cincinnatus BLOG *** Political Commentary - Social Commentary

The 50 million American families who work hard and pay their mortgage promptly each month may view this current $275 billion mortgage-refinancing scheme as inherently unfair. Your chances of winning this lottery are greatly enhanced, if you made no down payment, you bought more house than you could afford and defaulted on your payments. If you foolishly worked hard and paid all your bills on time your chance of winning is practically zero.  

In 2008 there were approximately 2.5 million foreclosures out of the 55 million mortgages outstanding, a rate of about 4.5% or 25% of the 10 millions homes that are “underwater” - i.e. the house is worth less than the outstanding mortgage. It is reasonable to assume that the ability to make monthly payments is the driver for most homeowners to stay in their primary residence rather than the value of their home relative to the outstanding mortgage. If this is the case, than employment levels and debt burden are more likely to be predictive of future foreclosure rates than home prices. A family that has an emotional attachment to their home will probably stay in it and continue to make regular monthly payments even if the current projected selling price is lower than their mortgage. In all likelihood most people view their home as a long-term investment that will ultimately appreciate and the current downturn in prices is merely a blip in a secular growth trend.

The current plan rewards bad behavior by either refinancing the mortgage to a lower quasi-government guaranteed rate or potentially reducing the principal amount of the mortgage. The objective is to cap mortgage payments at 31% of income for the lucky 9 million and thereby, reduce foreclosures and put a floor under home prices. There are several flaws in the logic of this plan, not the least of which is that it assumes that people who have been financially irresponsible will suddenly find religion and pay their bills in a timely manner - if we only reduce the monthly amount. It may work for some but don’t be surprised if it doesn’t alter the behavior of many of the intended recipients.

A second glaring in flaw is that there is no potential repayment or upside for the taxpayer who is assuming this additional risk. On simple fix would be to give the taxpayers a percentage of the gain when the house is ultimately sold. Since the average American moves every 7 years or so, the money could be returned to the taxpayers in a reasonable period of time.