The government's effort to streamline its refinancing program for mortgage borrowers who owe more than their homes are worth will amount to a wealth transfer from investors. But which investors? And how much of a transfer?
Domestic banks are the largest holders of securities issued by Fannie Mae, Freddie Mac and similar entities, according to data from the Federal Reserve (see charts). (About half of banks' securities portfolios are made up of mortgage bonds backed by the government.)
If a recent estimate of the impact of changes to the Home Affordable Refinance Program on the value of mortgage bonds is on target, banks stand to absorb a $4.5 billion hit based on the proportion of the securities that they own.
Struggling borrowers can be expected to increase their spending more than private investors would reduce theirs, however, according to a Congressional Budget Office working paper. With foreign investors also chipping in (they held about $1.1 trillion of agency bonds at June 30), the initiative is likely to stimulate the economy, the analysis concluded.
Some analysts have argued that while bondholders are not entitled to higher yields because borrowers cannot access market rates due to refinancing frictions, episodic government interventions could still prompt surly investors to pull back and drive up consumer prices.
Estimates generally anticipate only modest additional volume under revisions to HARP, however. Those revisions would, among other things, lower risk-based fees charged by the government-sponsored enterprises that add to borrower costs, and reduce the risk that originators will have to buy back faulty loans, inducing greater participation by lenders.
In a note after the government announced the new policies, analysts with Amherst Securities Group LP wrote that while they believe the official projection that refinancing volume under the program could double is realistic, trading in mortgage bonds had "more than priced for the change."
The Federal Housing Finance Agency, the GSEs’ regulator, itself emphasized that the roughly 900,000 HARP loans since the program was launched in early 2009 only accounted for about 10% of total Fannie and Freddie refinancings. Another 900,000 refinancings under the program until it ends in December 2013 would amount to roughly the same pace of HARP activity.
Assumptions made in the CBO paper, which was published the month before the HARP changes were announced, led to a much larger estimate of additional volume at 2.9 million loans.
That would translate to 111,000 fewer defaults (borrowers could meet their obligations more easily at lower interest rates), saving the government $3.9 billion in losses it would have otherwise incurred from bad loans, offset by a $4.5 billion reduction in the fair value of mortgage bonds owned by the Fed, the GSEs and the Treasury Department, according to the analysis.
Other investors would have to absorb a fair-value loss of $13 billion to $15 billion, and refinanced borrowers would pocket $2,600 each over the first year at lower rates.
"The stimulus is likely to be small as a percentage of [the total economy], but large relative to the net federal cost of the program," the paper said.
To be sure, the impact to banks goes beyond the value of their bond portfolios. There are fees for closing loans, and some banks could gain customers and others lose them as borrowers refinance with different lenders.
Indeed, the level of activity is largely up to the big banks. Analysts have noted that the pace of refinancing has been much higher at JPMorgan Chase & Co. and Wells Fargo & Co. than at Bank of America Corp.
In a report, analysts at Barclays Capital wrote that if the new policies, and B of A’s buyback settlements with the GSEs, induce it to "fully turn on the HARP switch," it could move the needle substantially.