Why Obama's Mortgage Plan is Not a Flotation Device

Pacta sunt servanda is Latin for promises must be kept. In the debate over what to do about America’s mortgage mess, the pacta sunt servanda crowd is the one saying that if you owe it, you must pay it. All of it—no matter if you bought at the peak of the market, borrowed way too much, and are now living in a home that’s so far underwater it has a periscope. The opposite view is that over-indebtedness is hampering the economic recovery and that it’s in the public’s interest for lenders to absorb more of the pain for making dumb loans. (I guess you could call that the illegitimi non carborundum camp.)

The Obama Administration seems sympathetic to the latter view. But it can’t get too squishy and forgiving for fear of turning more independent voters into outraged Tea Party activists, not to mention angering the shareholders of banks that made those dumb loans. That political calculus goes a long way toward explaining why the latest round of mortgage relief out of Washington is so limited.

The Administration’s latest mortgage plan, previewed in the State of the Union address and then announced in Falls Church, Va., on Feb. 1, wouldn’t do anything about reducing what borrowers owe. All it does is make it easier for them to service their debt by liberalizing rules on refinancing for people who are current on their loans. That could save eligible borrowers an average of $3,000 a year, the Administration says. (Some of the plan requires Congressional approval.) But if you were underwater before, you’ll be underwater by just as much afterward. You’re trapped in your house, which isn’t a recipe for a robust recovery. Home prices have fallen by one-third since their July 2006 peak, according to the latest S&P/Case-Shiller report. About 11 million homes are worth less than their mortgages, and about one in eight homes with a mortgage is either delinquent or in foreclosure.

In late January, the Obama Administration announced another initiative that did attempt to reduce mortgage balances, but it was a bit of a tiptoe. The revised Home Affordable Modification Program will pay Fannie Mae and Freddie Mac to forgive debt on homes that have lost value. In other words, even though Fannie and Freddie are effectively owned by the government, the Obama Administration finds it necessary to give them financial inducements to reduce the principal on certain loans. “This is a hoot,” Thomas Lawler, an economist and former Fannie Mae executive, told Bloomberg News reporter Lorraine Woellert.

The state attorney generals have been more aggressive, developing a tentative $25 billion settlement with loan servicers over foreclosure practices such as “robo-signing.” The states, not the feds, have taken the lead on that settlement. Holdouts New York and California, which balked at liability releases in that settlement, must decide today (Feb. 6) whether to sign on. About $17 billion of the tentative $25 billion would go toward principal reduction. (Even so, some people think even this deal is yet another win for the banks.)

Law professor Alan White contends that the Obama Administration needs to do more to fix what he calls the permanent foreclosure crisis. White, who teaches at Valparaiso University Law School in Indiana, wrote on the Credit Slips blog last week: “Nothing about the refinancing strategy moves forward the process of realigning mortgage debt to home values. Instead, the strategy relies on the doubtful proposition that home values will soon return to rising at their pre-2007 clip. Pacta sunt servanda and the housing market and broader economy be damned.”

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