Want to stimulate the economy and lower the foreclosure rate without adding a dime to the federal deficit. Not possible you say. Not so, says Morgan Stanley. Economists at the Wall Street firm are promoting what they are calling the Slam Dunk Stimulus plan, which they say could add $46 billion a year to the economy. The plan is getting attention in Washington. On Tuesday, a Morgan Stanley top economist ran the idea past members of the Senate Banking Committee (h/t calculated risk):
The Fed – and market forces – have pushed mortgage rates to historic lows. However, many homeowners are unable to take advantage of the low rates because they are blocked from refinancing by a high loan-to-value ratio (LTV), appraisal problems, unemployment, and low credit score, etc. This problem could be addressed if the Government merely recognized the guarantee that already exists on the principal value of a very large portion of the mortgage market – specifically, the mortgages that are backed by Fannie, Freddie and Ginnie – and acted to streamline the refi process.
So the plan is to take people who already have a Fannie and Freddie backed mortgage, many of which currently have a mortgage rate of nearly 6%, and refinance them at today’s rates of about 4.5%. Those people will then take that money that they are not sending to the bank each month and spend it on clothes or TVs or iPads or whatever. And presto, a $46 billion boost to the economy. What’s more, the better mortgage terms means that many of those people who would have ended up not being able to pay their mortgages will avoid foreclosure. Brilliant, right? So why are bloggers and others attacking the plan as silly and wasteful. Here’s why:
The fact that people are attacking the plan doesn’t mean it’s a bad one. In fact, it seems reasonable to me. But Morgan Stanley is overselling it a bit. First of all, the idea that you could stimulus the economy and it not cost a dime is silly. And like all others this one will have a price tag. Calculated Risk points out that at the very least it will cost money to refinance people:
The analysts also display a complete lack of understanding about the refinance process, transactions costs, and mortgage rates. E.g., the authors, presumably citing Freddie Mac’s Primary Mortgage Market Survey on average 30-year mortgage rates, note that current rates are about 4 ½%. However, that 4 ½ % “quote” (the latest survey showed 4.56%) includes a 0.7 point fee. More important, however, there are SIZABLE transactions costs associated with refinancing a mortgage.
Yes, typically it costs money to refinance a mortgage. But again the federal government already owns these mortgages. So there would be no need for new title insurance or application fees that are typically charged by mortgage brokers. And the government could wave taxes. So this is really a bogus argument.
Where the plan could end up costing big bucks is when you refinance people who might have paid their mortgage in full anyway. All stimulus plans rope in people who don’t need it, and this one would as well. (h/t marketwatch):
However, analysts at investment bank Keefe, Bruyette & Woods, in an Aug. 2 report, contend that the short-term stimulus effects would be countered by major additional losses in a wide-variety of areas.
A sweeping refinancing would result in a direct cost to the government in the form of significant losses to government-controlled mortgage giants Fannie Mae and Freddie Mac, which own almost $1 trillion in mortgage-backed securities according to Fannie and Freddie’s June 2010 summary report. Keefe analyst Bose George argues that Fannie and Freddie would experience total losses of about $75 billion from such a major refinance initiative.
That figure is probably inflated as well. Some of those people would end in foreclosure anyway. So some of that $75 billion you end up losing anyway. The question is not really how much you lose from refinancing, but how much you save by keeping at least some of those people out of foreclosure.
Lastly, some are attacking the program as nothing new. And they are right to say the government’s home loan modification or HAMP was similar to this plan and had the same idea. But HAMP didn’t go far enough in letting people refinance their mortgages. And that matters. Here’s the point: when it comes to stimulus the scale matters, and that’s where the Slam Dunk Plan, despite its costs seems worth it. It’s not just about keeping people in their homes. It’s about boosting the economy, increasing tax revenues and hopefully creating jobs. So if the HAMP program is expensive and only ends up modifying a few hundred thousand mortgages then it’s a failure. That’s not going to be enough to stimulate the economy. But save millions of people money on their mortgages and you have a shot of offsetting the cost of the program by setting off an economic chain reaction that could boost growth and create jobs. Perhaps not a slam dunk, but worth a shot? Maybe.