This article examines the recent revisions made to the Administration’s Home Affordable Refinance Program (HARP) and analyzes its actual effect on the real estate market.

Giving HARP another listen

The Federal Housing Finance Administration (FHFA) has announced major revisions to the Home Affordable Refinance Program (HARP), which was originally introduced in 2009.

HARP 2.0 includes numerous revisions that will purportedly provide mortgage refinancing to a greater number of underwater homeowners than were helped by the previous incarnation of the program. The most noteworthy revision under the new and improved HARP is the elimination of a maximum loan-to-value (LTV) ratio for qualifying participants.

To qualify for HARP, a homeowner must:

  • have a mortgage that was sold to Fannie Mae or Freddie Mac prior to April 1, 2009;
  • have an LTV above 80%; and
  • be current on their mortgage, having made no late payments in the past six months and no more than one late payment in the past year.

While the major benefit touted by the FHFA is the added disposable income resulting from lower monthly mortgage payments, they are aggressively pushing the idea of refinancing under a shorter loan term. By doing so, the FHFA claims homeowners will quickly pay their way out of their negative equity misery, thus restoring the housing market’s equilibrium as more homeowners are able to see the light of day.

No help for negative equities

Although the HARP revisions are a cute effort to offer California’s 2,500,000 underwater homeowners a chance to refinance at today’s low interest rates, the program unfortunately does nothing to solve the negative equity crisis that is driving this Lesser Depression. [For more information on the Administration’s other failed homeowner assistance programs, see the June 2011 first tuesday article, More bad news for HAMP.]

Designed to put a few hundred dollars of disposable income back into the pockets of underwater homeowners, HARP 2.0 seems to be more a modest economic stimulus program than a real effort to keep people in their homes. The notion that homeowners ought to refinance at a lower rate with a shorter loan term to begin turning their home right side up is, quite frankly, silly sophistry — they will nevertheless remain economic tenants in an underwater home they “own” on paper only.

Homeowners will nevertheless remain economic tenants in an underwater home they “own” on paper only.

The FHFA’s assertion that refinancing with a shorter loan term will accelerate a homeowner’s recovery from negative equity depends entirely on the money illusion that home prices will pick up again in the relative short term. The past 30 years of solid housing market growth in the U.S. has conditioned the home-buying public to think that home prices always recover and exceed prior highs. [For a more detailed analysis of how the money illusion pervades the California real estate market, see the December 2009 first tuesday article, The flat line recovery: a side-effect of sticky housing prices.]

Even given California’s in-your-face reality of steadily diminishing prices over the last five years, real estate professionals as well as buyers and sellers are behaving as though the illusion of perpetually rising home prices still holds true. Unfortunately, all fundamental economic indicators point to the fact that real prices will not increase for a very long time and they will likely never reach prior highs (when adjusted for consumer inflation).

The hole we’re in

One of the few universal truths in the real estate market is that home prices and interest rates have an inverse relationship. Home prices typically only increase when the interest rate falls and vice versa. Today, prices are at all-time lows and real interest rates are at or near 0% on any given day. Thus, interest rates cannot fall any further making it very unlikely that we will see a price increase any time soon. That is unless there is a spike in job growth or an explosion of density within our population — neither being very likely occurrences. [For a closer look at the rates affecting real estate, see the October 2011 first tuesday article, Current market rates.]

The only other period in U.S. history that bore witness to both low home prices and low interest rates was the Great Depression. It took nearly 20 years and a world war stimulus to return housing prices to stability after the Great Depression. Even then, prices picked up because gross domestic product (GDP) outpaced consumer inflation, which at the time ran at a steady two to three percent. Lamentably, this is an economic recipe we are nowhere near approaching today.

Even if all of California’s 2.5 million underwater homeowners were to refinance under HARP and follow the FHFA’s suggestion to take a shorter loan term, the negative equity plague in California would be unlikely to show any signs of abatement. So, in three to five years, after California homeowners have refinanced under HARP at shorter loan terms, thus seeing little to no change in their monthly payments, they will be right back where they started from: underwater, out of cash and wondering why they thanked the Administration for offering a tiny bandage to cover their gaping financial wounds. [For more information on California’s untenable negative equity predicament, see the February 2011 first tuesday article, The negative equity plague: California’s home insolvency crisis.]

Let’s forget about the feeble attempts to pander to voters (read: homeowners) just before an election year and focus all efforts on the one economic factor that will turn California’s floundering real estate market around: jobs.

Otherwise, gird yourselves for another round of strategic defaults in 2016. [For more information on strategic defaults, see the July 2011 first tuesday article, Strategic default smarts.]