Congress has finally passed, and the President has signed, H.R. 3221, formally known as the Housing and Economic Recovery Act of 2008 . More informally, the bill is being touted as the Mortgage Bailout Bill. While many agreed that the government should do something, few agreed as to WHAT that “something” should be.

So, is this bill the homeowners, or the mortgage industry’s, salvation? Let’s look at some of the provisions, limits and dollars included in the bill.

The first thing we note is NOT what is actually in the bill, but in how it has been received. President Bush signed the bill into law on Wednesday July 30th. The day before, he signed the Clean Boating Act of 2008 into law. According to my observation, the boating act got more attention. Why? Well the reality is that the mortgage bill is, in a sense, window-dressing. The bill provides for:

1. The strengthening and modernizing of the the regulation overseeing the housing government-sponsored enterprises (GSEs) - ­ Fannie Mae and Freddie Mac - as well as the Federal Home Loan banks.
2. Expanding the housing mission of these GSEs, and creating a new program at FHA that will help at least 400,000 families save their homes from foreclosure by providing for new FHA-insured loans
3. The creation of a NEW, and independent, “world class” regulator for the GSEs. The legislation gives this new regulatory body broad new authority. In fact, this new authority is equivalent to the authority of other federal financial regulators. Their goal is to ensure the safe and sound operations of the GSEs. There are several responsibilities outlined in the bill, but a key one is the ability to review and approve new product offerings.
4. New affordable housing provisions, including the ability to vary the maximum loan amount in high cost areas to as much as 50% more than the conforming loan limit.
5. A new Housing Trust Fund and a Capital Magnet Fund, financed by annual contributions from the enterprises, which will used for the construction of affordable rental housing.
6. The HOPE provision, which will provide for the refinancing of distressed loans through the FHA at a significant discount for the homeowner.

There are many other provisions, but these are the main ones. While they sound great, on the surface, there are reasons why the bill hasn’t created widespread jubilation. Like so many things, you take the good with the bad, and there are some definite “bads” with the bill. Let’s look at the main ones.

1. There will be NO investor or lender bailout. Investors and/or lenders will have to take significant losses in order to benefit from the proceeds of the loans refinanced with government insurance. So the refinance of distressed loans requires that the lenders take deep discounts. If the lender is not willing to take the discount … the homeowner isn’t eligible.
2. Borrowers will pay for FHA insurance, and will NOT be able to receive a “windfall”. That means that in exchange for the discount, homeowners will share future appreciation with the FHA equally.
3. The refinance program is VOLUNTARY. No lender, servicer or investor is required to participate.
4. Only owner occupied properties are eligible, so no second homes or investor properties.
5. Borrowers must prove that they are unable to afford their mortgage payment, AND they must certify that they have not intentionally defaulted to qualify for the program.
6. The bill only provides only $300 billion in funds, and is intended to aid only 400,000 homeowners – by insuring 400,000 loans.
7. All subordinate liens must be extinguished. In other words, if there is a second mortgage, it must ‘go away’.

Now you might be thinking that these “bads” seem pretty reasonable, especially in exchange for a bailout, and that may indeed be the case. However, let’s look at a couple of the realities of the bill.

First, lenders need not participate, so the homeowner could face foreclosure if the lender is unwilling to share in the loss. Now the logic behind the bill is that these discounts should be less than the losses associated with foreclosure, but that may depend greatly on where the home is located, and how much values in that market have declined. We may see homeowners in states like California and Florida benefitting far more than, and even at the expense of, homeowners in other states where property prices did NOT rise out of control for many years. Another major concern is ‘denial’. Even today, with all that is happening in the mortgage world, many banks remain in denial about their portfolios and their potential losses. These banks will likely drag many homeowners down … right up until the time they are taken over by the fed.

The bill is also intended to shore up credit markets. Banks and investors have been very fearful of extending new mortgage loans, in part because they just don’t know what property prices will do, and because they are holding large portfolios of subprime and non-performing loans, and they just don’t know what these loans are worth. Even if the bill gives some comfort to lenders, they must share in the losses. Credit markets always over-react, and can be slow to recover. We will likely see tight credit in the housing market, at least through 2009. In fact, we may not see credit markets loosen until property values have stabilized and foreclosures level off and then decline dramatically … YES, dramatically.

The $300 billion sounds great, especially if you’re a distressed homeowner, but 400,000 homeowners is a small number. In fact, I estimate that 400,000 may only represent 15-20% of the total foreclosures. If that is the case, then the likelihood of homeowners in California, Florida, Nevada and Arizona receiving the lion’s share of the funds seems very likely. A California homeowner who bought a home 2 years ago for $720,000, and put little or nothing down, may get a $200,000 discount. That $200,000 discount could help 4 homeowners in Texas, or Virginia, or Colorado. There was no consideration given to any kind of rationing or allocation of funds. However, if we divide 400,000 loans into $300 billion, we actually get $750,000 per loan, so it seems likely that this $300 billion will go further than planned, especially given the requirement that lenders share in the write-down.

All in all, the bill is a mixed bag, and that’s based on the content – I’m not even going to address the question of “whether” the government should be bailing homeowners out – we’ll deal with that issue next time.

Stay tuned here for more updates on the fun side of society’s collapsing financial infrastructure.