Sunday, March 28, 2010

Obama's New Housing Program Is a Huge Gift to Banks

Dean Baker does a great job of explaining what it will do. And, while Baker does imply that the Administration may have been a bit naive in structuring the program this way, I doubt it. Further, you can be sure that Lloyd Blankfein and Jamie Dimon understand exactly what this structure means. Here's Baker:

 The latest Obama administration initiative aimed at easing the nation's foreclosure crisis may be well-intentioned, but fails to give proper consideration to the state of the housing market. The biggest winners are likely once again to be the banks. In particular, holders of second mortgages are likely to see this program as a huge bonanza.

The program provides a substantial incentive for holders of first mortgages to reduce principal by having the Federal Housing Authority (FHA) guarantee a new loan at 97.75 percent of the current market value. In many cases this would be far more than the holder of the first mortgage would collect if the loan went through a foreclosure process. However, the payment on the second mortgage would be unaffected.

By substantially reducing the required payment on the first mortgage, the program will be creating a situation in which the second mortgage -- which would be worth little or nothing in foreclosure -- will suddenly again hold considerable value. This will be a huge windfall for second mortgage holders. It is worth noting that the major banks have vast portfolios of second mortgages.
This has the distinct odor of inside bankers all over it.

In every mortgage book ever written, first mortgages are paid off in full before second mortgage holders see a penny. In this structure, the firsts are written down to the benefit of the seconds. One has to ask, "What prompted the bankers to go out and buy these seconds at pennies on the dollar, in the first place, that will now rocket in value?"

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