Can policy trump flagging confidence?

The Obama housing rescue plan announced today is a bet that the answer is yes. From foreclosure-afflicted Mesa, Arizona, the President unveiled a plan to commit from $75 billion to $275 billion of U.S. Treasury and Federal Reserve funds on policy actions whose goal is to end a wealth-destructive stalemate between lenders and homeowners with troubled or potentially imperilled loans.

In an effort to break the forward momentum of a foreclosure tsunami economists and housing analysts predict could reach upwards of 8-to-10 million homeowners and deflate the value of millions of others' No. 1 asset, the President and his team have designed a plan that has three principle elements aimed at helping 9 million people stay in their homes, as reported today in the Wall Street Journal.

The Obama administration's plan has three main elements: an effort to help homeowners refinance; another effort to help stabilize the housing market through a $75 billion initiative aimed at reaching up to four million at-risk homeowners; and a third element that aims to drive down mortgage rates.

"The effects of this crisis have also reverberated across the financial markets," President Obama said. "When the housing market collapsed, so did the availability of credit on which our economy depends."

The administration pledges government money to separately entice homeowners, mortgage companies, and mortgage investors to rework loans. It would help a variety of homeowners, including those whose mortgage is more than the value of their home.

The housing plan is part of a broader effort by the government to address the volatile economy, and it comes after Congress passed a major stimulus package and the Treasury Department released its plan to shore up the banking sector.

Economists and housing experts' concerns with the plan will take one of two essential points of objection. 1) While it may slow the damaging rate of foreclosures and ease the impact of adding new supply to an already glutted market of existing home inventory for sale, the plan does nothing to spark or prime the demand pump; and 2) While it may help homeowners who bought their homes in good faith and have gone underwater on their loans due to their home's value declining, the plan aids too many people who took unscrupulous advantage of an easy-money era, either on the borrowing side or the lending side.

Here's how housing economist/commentator Calculated Risk phrases his objection to part 2 of the plan:

For homeowners there are two key paragraphs: first the lender is responsible for bringing the mortgage payment (sounds like P&I) down to 38% of the borrowers monthly gross income. Then the lender and the government will share the burden of bringing the payment down to 31% of the monthly income. Also the homeowner will receive a $1,000 principal reduction each year for five years if they make their payments on time.

This is not so good. The Obama administration doesn't understand that there were two types of speculators during the housing bubble: flippers (they are excluded), and buyers who used excessive leverage hoping for further price appreciation. Back in April 2005 I wrote: Housing: Speculation is the Key

[S]omething akin to speculation is more widespread – homeowners using substantial leverage with escalating financing such as ARMs or interest only loans.

This plan rewards those homebuyers who speculated with excessive leverage. I think this is a mistake.

Another problem with Part 2 is that this lowers the interest rate for borrowers far underwater, but other than the $1,000 per year principal reduction and normal amortization, there is no reduction in the principal. This probably leaves the homeowner far underwater (owing more than their home is worth). When these homeowners eventually try to sell, they will probably still face foreclosure - prolonging the housing slump. These are really not homeowners, they are debtowners / renters.

An assumption within this $75-to-$200 billion bet is that this massive redistribution of money, debt, and equity among those who struggle to pay their loans doesn't backfire. If people who are capable of paying off their mortgages suddenly start mailing it in to get some of the government beneficence, the cure could start a massively more lethal sickness. Society depends, somewhat fragilely on the fact that most responsible homeowners covet a good credit rating, and regard paying their mortage as fulfilling an unbreakable promise. This ethic will get a good test as aid to so many homeowners seems only a missed monthly payment or three away.

Here's the New York Times' David Leonhardt on that sensitive issue:

A plan that does not aim to help all underwater homeowners, or anywhere close to all of them, has many advantages. About $500 billion worth of mortgage debt is now underwater, and the number may eventually get close to $1 trillion. A plan that tried to put this debt back above water would be vastly more expensive than the one Mr. Obama announced today. It would also deliver less bang for the buck, since a great majority of underwater homeowners are likely to continue making their monthly payments.

Likely to get high marks from most ideological sides of the spectrum are the initiatives to increase funding to Fannie Mae and Freddie Mac aimed at stoking liquidity and getting banks to resume lending, per the WSJ sum up.

· Promoting Stability and Liquidity: In addition, the Treasury Department will continue to purchase Fannie Mae and Freddie Mac mortgage-backed securities to promote stability and liquidity in the marketplace.

· Increasing The Size of Mortgage Portfolios: To ensure that Fannie Mae and Freddie Mac can continue to provide assistance in addressing problems in the housing market, Treasury will also be increasing the size of the GSEs’ retained mortgage portfolios allowed under the agreements – by $50 billion to $900 billion – along with corresponding increases in the allowable debt outstanding.

· Support State Housing Finance Agencies: The Administration will work with Fannie Mae and Freddie Mac to support state housing finance agencies in serving homebuyers.

· No EESA or Financial Stability Plan Money: The $200 billion in funding commitments are being made under the Housing and Economic Recovery Act and do not use any money from the Financial Stability Plan or Emergency Economic Stabilization Act/TARP.

The Associated Press reports on how Wall Street investors reacted initially to Obama's new housing strategy. After the wild, gravity-borne gyrations that occurred in the moments U.S. Treasury Secretary Timothy Geithner opened his mouth last week to speak about what would happen with TARP money, a flat market is a virtual Wall Street thumbs up on the plan.

Clearly, if Obama's plan can at least fulfill its promise of keeping 9 million people in homes they own, it will redound to stabilizing the most treasured asset among those who account for two-thirds of the U.S. economy, consumers.

Most denizens of housing -- be it in for-rent, for-sale, market rate or low income -- would count that as a good place to start.