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4 July 2005
Author�s Note:
Home Owners Loan Corporation II was established by the Congress on August 7,
2007. The following is a transcript of the chairman�s introductory comments at
the first board meeting, held September 12, 2007.
�Before we begin
our deliberations on how to cope with the wave of foreclosures sweeping the
country, a word about our predecessor institution.
Home Owners Loan
Corporation I
The first Home
Owners Loan Corporation (HOLC I) was established by Congress in 1933 to help
families avoid having their homes foreclosed in the worst depression this
country had ever seen. HOLC I refinanced loans of borrowers with mortgages in
default, or held by distressed institutions.
HOLC I largely
succeeded in its mission, refinancing about 20% of all qualifying home mortgages
in the country, liquidating itself in 1951 at a slight profit to the Government.
This history no doubt was instrumental in the Government reviving the model this
year to deal with the current crisis in home finance.
The New Crisis in
Housing Finance
This crisis is
quite different from the one faced by HOLC I. Instead of a depression, we have
had an eruption of inflation, comparable in magnitude to the one we experienced
in the late 70s and early 80s. As then, the inflation has caused a sharp spike
in interest rates, but the consequences of the recent rate spike have been much
worse. It punctured the housing bubble, with house price declines especially
large in areas where appreciation had been strongest. New construction in such
areas has been cut in half, and construction of condominiums has ceased almost
entirely.
Another major
difference between this rate spike and the previous one is that this time we had
many more mortgages with little or no equity before prices started to
drop. This reflects both the widespread use of 80/20 first and second mortgage
combinations in the financing of home purchases, and extensive cash-out
refinancing for purposes other than building equity. In addition, a substantial
proportion of outstanding mortgages are adjustable rate (ARMs), many with the
option to pay interest-only, and in the case of option-ARMs, even less.
It is estimated
that 9 million mortgages are now underwater -- the loan balance exceeds the
value of the property. A large proportion of those are interest-only and option
ARMs, on which the interest rate and mortgage payment are rising as we speak.
Home Owners Loan
Corporation II
As per its
instructions from Congress, HOLC II will follow its predecessor in refinancing
mortgages in some stage of default but not yet in foreclosure. However, where
Congress set eligibility requirements for HOLC I, it has delegated this
responsibility to the board of HOLC II. The only guidance we have is that
eligible borrowers should be those in distress �through no fault of their own,�
and that we cover our costs over the life of the agency, as HOLC I did.
Our staff
recommendations for defining eligibility are considered to be consistent with
the Congressional guidelines.
1. We will only
refinance mortgages on which the balance does not exceed our estimate of
�long-run sustainable value� (LRSV). The LRSV will be above current market
prices but below the prices reached before the crash. HOLC I followed a very
similar rule.
2. Only mortgages
secured by the borrower�s primary residence will be considered. Mortgages on
second homes and rental properties are not eligible.
3. Mortgages
larger than $1 million will not be eligible.
Unfortunately,
less than one of 10 of the mortgages now underwater meet these conditions. A
large proportion are in what had been the hottest markets, where current prices
are well below LRSVs, and balances had not been paid down because of the
popularity of interest-only and option ARMs. Many of the underwater mortgages
are on second homes and rental units which had been purchased on speculation.
And a surprising number is larger than $1 million, with a concentration in
California.
Unlike HOLC I,
HOLC II has no authority to refinance loans held by distressed institutions if
those loans are not otherwise eligible. The earlier Congress was concerned about
bank failures, which could cause loss to depositors � deposit insurance did not
arise until several years later. The Congress establishing HOLC II had no such
concerns. It took the position that lenders who loaded up on inherently risky
ARMs in go-go markets should bear the full consequences of their folly.�
Copyright Jack
Guttentag 2005
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