This past October, the Obama administration proposed a new plan to help distraught homeowners. The key to the new proposal was to get lower-interest mortgages into the hands of folks living in devalued homes.
The proposal was not without withering criticism, most of it from pundits who don’t believe the plan gets to the root of the housing market problem: underwater mortgages.
The new policy likely will not have much of an impact on the housing market or the broader economy, reported Ted Gayer, co-director of the economic studies program at the Brookings Institute. If one is looking to stem the tide of foreclosures, he said in press reports, this new plan doesn’t get at the underlying problem: that a quarter of all mortgages are underwater.
A better, more radical plan has come forward from an unlikely source: Marty Connor, chief financial officer at Toll Brothers Inc., the $1.5 billion, publicly traded homebuilder based in Horsham, Pa.
I called Connor to discuss his unusual proposal, but first a note on the Obama plan in which the Federal Housing Finance Agency would allow qualified homeowners to refinance, although their homes might have declined in value. The program broadens the terms of the seriously underused 2009 Home Affordable Refinance Program (HARP). FHFA, which oversees Fannie Mae and Freddie Mac, said the mortgage giants would eliminate or reduce some fees and waive risk for participating lenders.
Although Toll Brothers has a mortgage subsidiary, TBI Mortgage Co., it is a homebuilder working mostly in the mid- to upper-end markets (average selling price of a Toll Brothers home is around $560,000) and generally doesn’t have a problem with delinquencies.
"We are not seeing big foreclosure numbers in the Toll Brothers neighborhoods," Connor said. "It’s an issue in places like Phoenix, Las Vegas and the Inland Empire of California, but 60 percent of our business is in the Washington, D.C., to Boston corridor and foreclosures are not a huge issue there, particularly in the suburban areas."
In addition, about 20 percent of Toll Brothers buyers pay cash, and of those getting a mortgage, the buyers average about a 30 percent down payment, said Connor. "So, people are leveraging 70 percent of the house and it takes a big backup in value to erode that 30 percent down payment."
Nevertheless, problems in lending and housing markets, and in particular, in the mortgage sector, affect not just national lenders but all homebuilders and, of course, other sectors of the national economy, so it really wasn’t unusual for Connor to take his own swipe at the problem of underwater mortgages.
Connor focuses on just one segment of the problem: homeowners who are employed and current on their mortgages but when they look at writing that big mortgage check wonder why they do it as their homes are worth less than the mortgage.
"It’s a $200,000 mortgage and my house is worth $150,000," thinks the homeowner. "I’m paying 6 percent or more on my mortgage because I don’t have enough equity to refinance. Why should I continue to do this?"
Connor’s solution is to divide the mortgage into tranches.
Take, for example, the beleaguered homeowner with that $200,000 mortgage. Connor’s idea is to take the $150,000 (that the home is worth) and put that into a first mortgage with a reset interest rate of 4 percent. Then a second mortgage of $50,000 is established.
"As the principal is amortized on the first mortgage, or as appreciation happens in the market — and it will happen at some point in the future — the second mortgage has some ability to be repaid or collected, depending on what side of the fence you stand on," he said.
This double-tranche mortgage does a number of things: It takes away the moral hazard; puts money in the consumer pocket, as they are paying 4 percent on $150,000 instead of 6 percent on $200,0000; restores pride of ownership; lowers the mortgage interest deduction on the tax return so the government gets more money; and it clears much of the foreclosure overhang.
The problem that I saw was that most mortgages are not free to be adjusted because they have been sold into residential mortgage-backed securities.
"Yes, in most cases that $200,000 mortgage has been securitized into the bond market, but it also has been guaranteed by the government through the GSEs (government-sponsored enterprises), so the government is on the hook already," Connor said. "In refinancing into two buckets, we don’t think it creates additional exposure for the government and actually increases its revenue through reduced mortgage interest deductions."
The biggest question in Connor’s plan is what happens with the second mortgage. Connor admits this is still the fuzzy part of equation. "The government would own the second — it can sell it if it wants to or not," he said. "The proposal would be a no-interest second mortgage, but maybe after two or five years interest would start to click in."
I also asked Connor why he was taking an interest in the mortgage problem.
"New housing employs so many people that we need to get the engine running again," he said. "As a country, we built a million-and-a-half housing units for 40 years and now we are building a half-million. Then there is the multiplier. It’s not just the builders but other folks as well, such as the guy who makes furniture that will go into the new home.
"We’ve been on record for so long about housing being so vital to the recovery of the economy, we also wanted to at least provide some food for thought on potential solutions. The government is looking at all sorts of situations; we wanted to make sure they were at least hearing about this."