We've gotten several questions regarding the prospects for President Obama's
mortgage foreclosure plan, as well as the likely implications of fiscal
stimulus for GDP growth (the bill was signed into law on Tuesday). As I've
indicated before, I am a fan of neither.

Mortgage Foreclosure Plan

Government officials have been playing around the edges of the housing crisis
for many months. First, there was Secretary Paulson's entry HOPE NOW, which
brought together key private sector players on a voluntary basis to encourage
mortgage modifications. Then there was the FDIC program, which Sheila Bair has
been pushing hard and has been implementing on IndyMac and other banks taken
over by the FDIC. Finally, there was the Congressional effort: Hope for
Homeowners, which was supposed to help millions at a cost of up to $300 billion
but at last count had resulted in a grand total of 25 modified loans.

Unfortunately, President Obama's plan is more of the same. First of all, it
might help to correctly define the problem. Politicians look at the situation
and figure that the problem is people are losing their homes due to
foreclosure. If we can slow down or stop foreclosures, the problem is solved.
As long as the government sees the problem in this way, it will not provide
effective solutions.

The root of the mortgage problem is that through a combination of bad
government policies (especially related to the regulation of Fannie and
Freddie), disastrously poor underwriting during the boom years, a massive
inventory overhang, and a weak economy, the housing market is entirely out of
whack in terms of supply and demand. The best way to fix that is to let prices
adjust until the market finds a price that matches supply and demand.

In 2007, the pressing issue was that adjustable rate mortgages were adjusting
upward, making existing mortgages unaffordable. The Fed has mostly taken care
of that problem by cutting short rates to 0%, but government officials still
seem to think that if only homeowners' mortgage payments could be lowered a
little, the foreclosure wave would disappear.

For the past year, the main problem has been fundamentally different. As home
prices fall, more and more homeowners are "underwater" in their mortgages, that
is, they owe more than their homes are worth. This is mostly because banks were
dumb enough to loan homebuyers money without requiring a significant (or in
many cases any) down payment (it's not really fair to call bankers dumb, since
they merely offloaded the bulk of their exposure to investors and the GSEs).
Moreover, even for those who started out with equity, there are plenty of
places around the country where home prices are down 20% or 30% or 40% from
their peak.

As each day passes, there are more homeowners who fall far enough underwater
that their best option is to give up. Stop paying your mortgage and wait to be
evicted. The Obama plan does nothing for them.

If the government wants to "fix" the housing problem, then it needs to think
about ways to stimulate home buying. I do not necessarily believe that we are
well served by having the government artificially distort the market, but given
that the Administration seems determined to prop up the housing market, maybe
officials could turn their attention to that front. Personally, I believe that
in the long run, we're best served by letting the market work. Home prices will
find their clearing level, and this will be the fastest path to moving on.
Artificially propping up home prices/housing demand more than likely will make
the pain less intense today but extend it over a longer period.

In any case, what are the specific issues with the proposal as it was laid out
this week (keeping in mind that the details will not be made public until March
4):

1. Limiting relief to the subset of homeowners who are facing foreclosure does
not fix the broader housing market. I highly doubt that stopping an "avoidable
foreclosure" makes anyone more likely to want to buy a house (though it might
help temporarily at the margin by limiting the foreclosure-related supply that
hits the market in the short run).

2. The refi piece of the plan only applies to homeowners currently in a Fannie
or Freddie loan. No help for subprime, Alt-A, or jumbo borrowers, who as a
group are probably the ones in the worst shape.

3. You can only refinance up to 105% LTV. Thus, anyone underwater is
essentially out of luck. Basically, the only homeowners this piece helps are
the ones who now have an LTV over 80%, which prevents a conventional refi under
today's tight underwriting environment, and somewhere just under 105%.

4. The modification program is more of the same. It differs from Hope for
Homeowners only marginally. The basic idea is that if the bank is willing to
lower the payment-to-income ratio to 38%, then the government will pay for half
of the cost of lowering it further to 31%. To use the example in the release,
for a homeowner currently at 43% payment-to-income, the bank would be on the
hook for 70% of the cost of the modification (all but 3 1/2% of the 12% move
from 43% to 31%). I'm not sure banks are going to be lining up for this deal.

5. The government will bribe -- I'm sorry, pay -- servicers $1,000 per loan as
well as offer other payments to entice bond holders and servicers to play ball.
That may help, but there seems to be a legal morass which has yet to be
untangled involving what constitutes the best interest of the bond holders.
Congress has passed safe harbor provisions, but so far, the legal complications
involved in the securitization process remain. I'll let the lawyers figure that
one out, but I doubt a $1,000 payment is going to be enough to make that issue
disappear.

6. This might be the biggest point. There is nothing in this plan to force or
even encourage banks to do modifications that lower principal. For all of the
households who are underwater, lowering the monthly payment at the margin DOES
NOT ADDRESS THE PROBLEM. I simply don't understand why government officials
can't get their hands around this concept.

7. Loan modification has proven to be relatively ineffective. Sheila Bair can
protest until the cows come home, but the data do not lie. A high percentage of
loans that are modified go right back into delinquency within a matter of a few
months. When principal is forgiven, the delinquency percentage is much lower,
but for the sorts of rate-relief workouts being proposed in this plan, the
repeat delinquency percentage appears to be close to 50%.

8. The rate relief is temporary (5 years max) and in many cases, homeowners end
up with a larger ultimate debt load, as the term of the loan is extended AND
the outstanding principal amount goes up.

9. By making homeowners who are still current on their mortgages eligible, the
government avoids the problem of inducing people to intentionally fall behind
on their payments. However, this means that the government will inevitably end
up subsidizing lots of folks who would have been fine without help.

10. More broadly, everything that the government does to subsidize those who
made imprudent decisions in boom times risks alienating the 90% who are making
their payments and have played it more conservatively. I hear more and more
people who have been faithfully making their payments say that they feel
foolish for doing so when there is so much help being offered to those who are
not paying.

11. Fannie/Freddie bog. This plan amounts to forcing Fannie and Freddie to
underwrite loans that no private player would voluntarily make. Granted, Fannie
and Freddie are government-owned and operated, whether officials want to admit
it or not, and using them to address the housing situation is something that
I've viewed as inevitable. Indeed, watch this space. Underwriting fees are
going to come down. In any case, we're crossing the Rubicon here. It is now
going to be impossible to unwind the nationalization of the GSEs easily or
quickly. Rather, they will be government wards for years. That might be the
right call, but that discussion should take place in the open, not snuck
through in an implicit way.

12. Mortgage cramdown. The Administration is asking Congress to pass mortgage
cramdown, presumably as a stick to get private players to "play ball." Congress
is already eager to pass cramdown legislation. Don't worry, they say. This
won't affect mortgage rates going forward because we'll only apply it to loans
made in the past. Come again? Legislators think that they can retroactively
violate legal contracts and then expect market participants to assume that
those contracts will never be violated again. Seriously. There's been more than
the usual amount of nonsense floating around Capitol Hill lately, but this one
is probably the most outlandish. In fact, cramdown would throw the entire MBS
market into disarray and, yes, it would increase mortgage rates noticeably
going forward. Not exactly the sort of thing that would serve to increase the
demand for homes, which, as pointed out above, should be the ultimate goal.

I'm sure I could go on and on, but I'll stop at a dozen. Suffice it to say, I
doubt that this package will do much to improve the housing market or the
economy. It will hopefully get Congress off of the Treasury Department's back.
If it allows Treasury leeway to put forth and execute a proper financial rescue
package, then I'd gladly accept it, but after last week's announcement, it is
not yet clear whether we're going to get that either.

Fiscal stimulus package:

I've been working on a long, more formal piece on fiscal stimulus in general. I
was hoping to have it out by now, but I'm still writing, so let me give a few
quick impressions on the fiscal stimulus bill.

1. Despite the massive size of the bill, less than $200 billion in "stimulus"
gets distributed in the current fiscal year. Almost as much goes out in FY2011
as in the next 7 1/2 months.

2. There is nothing inherently stimulative in the bill. We have spending on a
variety of worthy causes, but most of the money will go out long after the
economy is already on the mend. We have a bunch of one-off revenue provisions
for households that are essentially transfer payments (i.e. they do nothing to
impact marginal tax rates and therefore the incentives of households to work or
invest more). Politicians apparently haven't learned their lesson from last
year that people will save this money. Indeed, a broader point is that the
economy is (and needs to be) transitioning to a higher savings rate and the
government is doing its darnedest to get consumers to spend money. There are
small business tax provisions that have been tried repeatedly in recent years
to little effect. And finally, there are massive transfer payments, mainly to
state and local governments, and an expansion of a variety of entitlement
programs which will probably become permanent.

3. The damage to the fiscal outlook will be devastating. Not only will the
expansion to the entitlement network probably be permanent, but I'd also go out
on a limb and say that a lot of the spending just passed will make its way into
the baseline budget and therefore be permanent as well. Even if the intention
is otherwise, the government will have to spend more. If you build a road to
nowhere, it still has to be maintained.

So for those who have asked about the impact of this stimulus package on GDP,
I'll work from our projections from the 2008 stimulus. Our initial guess was
that last year's $150 billion package would be worth about 0.1% on GDP in 2008
(to be offset by a similar loss in 2009). Of course, it's impossible to say for
sure what the ultimate impact was, but I stand by my original projection. The
current bill is said to amount to $185 billion in the current fiscal year and
$400 billion in FY2010. That ought to be worth around 1/2% to GDP, but most of
it will hit next year, by which time we believe the economy will already be
growing at an above-trend rate. Meanwhile, deficits will be massive for years
to come and the government's debt burden will move up rapidly over the next
decade, the period when we were supposed to be preparing for the Baby Boomer
entitlement crunch.

Let's just hope that the financial rescue package turns out to be OK!
Otherwise, the economy will truly be on its own, and the government response
will be "3 strikes, you're out."

Sales of previously owned U.S. homes unexpectedly declined in January even as falling prices made them more affordable, signaling that the housing slump is further from a bottom than previously estimated.

Purchases fell 5.3 percent to an annual rate of 4.49 million, the fewest since 1997, the National Association of Realtors said today in Washington. The median price dropped 15 percent from a year ago to a six-year low of $170,300. Distressed properties accounted for 45 percent of all sales.

“This is actually a very disappointing set of numbers,” Ethan Harris, co-head of economic research at Barclays Capital Inc., said in a Bloomberg Television interview. “We’re still in this phase of the recession where it’s really kind of a dramatic pulling back” in purchases of big-ticket items, due to a “tremendous loss of confidence in the economy.....”

Confidence among U.S. homebuilders in April increased to the highest level since October, a sign low lending rates and government efforts to stabilize the housing market may be putting a floor on the industry’s slump.

The National Association of Home Builders/Wells Fargo index of builder confidence rose to 14 from 9 the prior month, the biggest gain since May 2003, the Washington-based NAHB said today. A reading below 50 means most respondents view conditions as poor.

Record-low mortgage rates and falling home prices are beginning to stir demand for housing after almost four years of declining sales. Still, inventories near record levels, spurred by foreclosures, indicate any recovery in housing will be lengthy as the economy remains mired in what may become the longest recession in seven decades.....

Grace and John Pitts got a 4 percent interest rate on a 30-year fixed mortgage when they bought their Cape Cod-style home in Quincy, Massachusetts, in 1951.

That was about the lowest rate anybody got in the next 60 years.

Those days may be returning as history provides Federal Reserve Chairman Ben S. Bernanke lessons on how to rescue the U.S. from the housing slump. Home loans may go as low as 4 percent if the economy worsens, said Robert Edelstein, a professor at the Haas School of Business at the University of California, Berkeley. Record foreclosures, falling home prices and an economy that has lost 5.1 million jobs since December 2007 will pressure Bernanke to further reduce borrowing costs.

“The Fed will have to do whatever it takes,” Edelstein said. “People will buy cheaper houses at very low interest rates.”

Conventional mortgages averaged 4.61 percent in 1951, 4 percent when backed by the Veterans Administration, and 4.25 percent by the Federal Housing Administration, according to “The Postwar Residential Mortgage Market,” a 1961 book written by Saul Klaman and published by Princeton University Press. Rates during the 1930s were as high as 7 percent.

Bernanke, a Harvard-educated student of the Great Depression who spent his 20-year academic career writing and teaching about the 1930s, is using his knowledge of that era to avoid the missteps policy makers made then. He’s bringing down mortgage rates, supporting the banking system, and buying back government debt and mortgage-backed securities to relieve the scarcity of credit.....

Yale University economist Robert Shiller has often dazzled audiences with a chart showing home prices from 1890 to present. Someone even used Mr. Shiller's chart to make a YouTube video that puts its viewer on a roller-coaster ride over peaks and valleys in home pricing. It's a bumpy ride.

Now another economist, Thomas Lawler, says Prof. Shiller's chart is "bogus." Mr. Lawler says Mr. Shiller cobbled together data that are inconsistent and sometimes unreliable. Mr. Shiller defends his work and accuses Mr. Lawler of making "wild allegations."

The clash is more than just a spat between two of America's most prominent housing mavens. It could affect the debate about exactly where the U.S. is in its housing cycle. The squabble also illustrates the paucity of reliable information on house prices.

If they rely too heavily on house-price gauges, politicians may get a distorted view of the severity of the slump and support overly drastic measures, says Kenneth Rosen, a housing economist at the University of California, Berkeley. Mr. Lawler says the Shiller chart also appears to understate the long-run rate of increase in home prices.

No one has found a precise way to measure changes in house prices. Because no two homes are exactly alike, changes in the price of one won't necessarily be matched even by apparently similar homes nearby, much less those hundreds of miles away. Though some indexes track price changes in the same set of houses over time, those can be distorted by major improvements in some of the houses and deterioration in others. The publicly recorded transaction prices, used to create indexes, often are distorted by incentives given to buyers that aren't tallied in the price.....

The head of Greenwich Financial Services LLC warned bond investors in Washington last month that government efforts to reverse the housing slump are doing more harm than good by undermining debt contracts.

More than 30 money managers with stakes in the $6.7 trillion mortgage bond market that underpins the real-estate industry heard Bill Frey’s March 25 talk, according to a list of the attendees. Since then, a group of investors with home-loan bonds totaling more than $100 billion have hired Patton Boggs LLP, Washington’s biggest lobbying law firm, said Micah Green, a partner and former head of the Bond Market Association.

Bondholders are preparing for a fight over legislation approved last month by the House of Representatives that would shield companies that collect homeowners’ payments from lawsuits over modified mortgages, even if new terms harm investors. The government’s actions may increase borrowing costs because creditors would demand higher returns to compensate for the risk that once-sacrosanct investment terms can be changed, they say.....

The closest thing to a real estate crystal ball in the last few years has been the house auctions that are regularly held around the country

In 2006 and early 2007, the official housing statistics were still showing that house prices were holding up. But that was largely because so many sellers were refusing to sell. The auctions, made up mostly of foreclosed homes, showed the truth: house values were starting to plummet in many places.....

We might be looking at a lost generation for U.S. home values.

Far too many analysts are calling a bottom to the housing market after home prices in 20 metropolitan areas declined at a slower pace in February, according to the Standard & Poor’s/Case-Shiller Index.

Don’t be blinded by the glint of optimism in headlines about rising consumer confidence and slowing price declines. Demographic and market realities tell a more sobering story.

You won’t see a widespread housing rebound in an economy in which 600,000 jobs a month are lost and foreclosures ravage the most overleveraged areas. These are just the visible barriers to a recovery.

Mortgage lending has also been an unusually tightfisted process of late. Lenders are demanding a 20 percent deposit for home purchases, and want impeccable credit ratings. About 45 percent of U.S. banks surveyed by the Federal Reserve said they had “tightened their lending standards on prime mortgages.” I suspect that number is much higher.

Then there’s the reality that the market is glutted with homes. A record 19 million homes stood empty at the end of 2008.

What you can’t see in the most recent housing numbers is the least-visible driver of home prices today: demographics.....