Rumors of new government involvement in the mortgage market continued this week. Last week, Morgan Stanley’s “Slam Dunk Stimulus” centered on allowing homeowners who have LTVs over 80% and/or poor FICO scores a chance to refinance, citing the savings to households from lower interest rates. The idea was countered by Barclay’s “Easier Said than Done” paper that argued the damage to bondholders and the current system for loan origination would not be worth the small benefit from lower interest rates.

A Reuters report this week sighted more and more banks alerting their clients to the possibility of some new program while Morgan Stanley might actually be pitching their idea directly to Washington. The Treasury’s response to the rumors this week was that they aren’t planning anything, and the rumors are nothing but just that. The FHA added their response sighting higher fees and tighter lending standards for loan originations (including refinancing), in order to recapitalize. Positive remarks indeed.

The back and forth will go on for quite a while I’m sure, and may never culminate into anything, but the action this week was certainly positive to bond holders. It’s evident now that the mortgage market in the US has been dysfunctional for decades. The pseudo privately owned model the GSEs operated under has since failed, but little can be done about that right now. It’s the only residential mortgage market currently so the environment will need much improvement before anything substantial changes. However,  if the new FHA fees do move the model for Ginnie (and in turn Fannie and Freddie) closer toward being self sustaining, then bond holders, taxpayers and the market as a whole are better off. But even if the government continues to shun Wall Street’s ideas now, we are all aware of what they can do if things worsen further.

The rumors should not be confused with other news from HUD today about a program to get creditors to forgive up to 10% of principal and refinance underwater non-agency mortgages into FHA loans. This was an adjustment to HAMP that was announced in March and planned for this fall. Jumpiness is coming from theories that the path to debt forgiveness will be a gradual one, which seems to have some validity considering the widely held view of the “new normal”, or below average growth and high unemployment.

Have a great weekend.

Cliff J. Reynolds Jr., Investment Analyst