joe Gagnon Thinks That the Obama Administration's HARP II Plan Has Promise--If It Is Properly Supported
RealTime Economic Issues Watch: US policymakers are running out of options to solve our massive unemployment problem and get the economy growing again. The Administration’s jobs bill faces resistance in Congress. The best option that can be implemented without a vote of Congress is to work through the market that started this mess in the first place—housing. The Administration has made a good start by announcing that it plans to make it easier for underwater mortgagors to refinance and repair their balance sheets, but some of the details to be filled in will be important in determining the ultimate effectiveness of the program. In addition, to boost the overall economy and to maximize the benefits of mortgage refinance, the Federal Reserve should announce new large-scale purchases of agency guaranteed mortgage backed securities (MBS) with the goal of keeping the 30-year mortgage rate between 3 and 3.5 percent through the end of 2012. These purchases would have beneficial spillovers into almost all other financial markets….
Some have proposed that the Fed announce a desired path for the future price level (or future nominal GDP) that is higher than that currently expected by the markets. It is argued that such an announcement would raise inflation expectations, lower real interest rates, and stimulate economic activity. However, it is not clear that such an announcement, by itself, would have much effect. Indeed, during the past two years, there has been little tendency for market forecasts to move toward Fed forecasts. To increase its effectiveness, any such announcement should be accompanied by concrete actions to push market conditions in a supportive direction. The best option available is a massive program of MBS purchases….
The target ranges should be 3 to 3.5 percent for conforming 30-year mortgages, and 2.5 to 3 percent for conforming 15-year mortgages and 10/1 adjustable rate mortgages (ARMs). To achieve these targets for mortgage rates, the Fed should aim for current coupon 30-year MBS yields of 2.5 percent, and lower yields on MBS with shorter maturities. Because the spread of mortgage rates over MBS yields tends to jump up when yields decline, the primary mortgage rate would start close to 3.5 percent and gradually decline over the first few months of the program as the backlog of applications is run down.
The Federal Housing Finance Agency (FHFA) announced on October 24 that it plans to strengthen and extend the Home Affordable Refinance Program (HARP) through December 2013… to allow borrowers whose loans are currently guaranteed by the agencies to refinance despite having loan-to-value ratios above the normal 80 percent limit…. Details on the latter point will be released by November 15, and these details will be critical….
Judging from the pattern of previous refinancing waves, a sustained decline in mortgage rates of 2 to 2.5 percentage points in combination with reform of HARP likely would cause a surge of mortgage originations equal to more than half of the existing stock of agency-backed home mortgages. That would total at least $3 trillion. The median decline in the mortgage interest rate would be more than 2 percentage points, implying an overall reduction in household interest expense of $60 billion to $80 billion per year…. Because of the long-lasting nature of these savings, the total effect on household spending would be greater than that of an equivalent but temporary tax cut.4 In addition, the availability of record-low mortgage rates for a fixed period of time likely would spur potential new home buyers into the market and boost home building and sales.
Even more important, if the Federal Reserve supported the refinancing boom by purchasing $2 trillion of new MBS, for example, the existing MBS holders would have to find another market in which to invest $2 trillion. This avalanche of money would surely push up stock prices, push down bond yields, support real estate prices, and push up the value of foreign currencies. All of these financial developments would stimulate US economic activity. Based on a recent Fed study (Chung et al 2011) Fed purchases of this magnitude would increase US GDP by more than 2 percent after about two years, creating nearly 3 million additional jobs. This estimate includes only a small part of the effects operating through the mortgage refinance channel discussed above, so that the total effects on the economy would be even larger, perhaps creating 4 million extra jobs or more.