Government intervention programs in the housing market are numerous. Mr. Shiller mentioned the first time homebuyer tax credit and the $1.25 Billion in Fed MBS purchases. Acronyms abound, with the HAMP modification program and the HREF refinancing program. There was TARP, which directed cash to struggling banks so that they might step up mortgage lending. There is an ongoing initiative aimed at encouraging principal reductions and deeds-in-lieu of foreclosure, where appropriate. There is the government conservatorship that still encases Fannie and Freddie. There is the FHA, which now now insures more than 1/3 of new mortgages. There are the discretionary funds awarded to states to fund experimental relief efforts. And of course there is the mortgage interest tax deduction, which was in place well before the housing crisis, but is worth pointing out nonetheless.

There are a few key threats to all of these programs. The first is one of financing: they are expensive to operate, and it’s unlikely that they will pay for themselves, despite the government’s insistence. The second issue is efficacy. The modification program, for example, has helped only a handful of eligible borrowers, and hurt many more by simply delaying foreclosure. Meanwhile, new evidence suggests that the interest tax deduction does nothing to spur home ownership. Finally, there is the issue of whether these programs are even producing outcomes which are desirable. “I don’t see anything being gained by holding housing prices higher than the market rate. It is difficult to see why the government would want to pursue policies that would encourage people to pay too much for homes,” Dean Baker recently told reporters. In short, it looks like time is running out.

The Fed has essentially stopped purchasing MBS, although it is currently debating whether to resume doing so. The homebuyers tax credit was renewed once, but is unlikely to be renewed again when it expires in May. The modification program is still alive, though generally acknowledged as a failure, and it could be completely closed soon. High default rates already threaten the solvency of the FHA, and despite premium increases, it may have no choice but to cut back on lending. Fannie and Freddie are safe until 2011 (according to Treasury Secretary Tim Geithner) although Congress has already indicated that they will be abolished. As for the mortgage interest tax deduction, the housing crisis revealed how counter-productive it was, and it could be one of the first things to go when the federal government gets serious about fiscal responsibility

So there you have it. The government clearly wants you to buy a house now! It will subsidize the purchase, facilitate the financing process, keep borrowing costs reasonable, and help you make payments if you get into trouble. Why wait, right? On the other hand, when the government pulls the plug, the bottom could fall out of the housing market. In which case, that FHA loan and $8.000 tax credit might start to look like a booby prize.

So what is a Deed-in-Lieu of Foreclosure? For borrowers who are behind on their mortgages, it represents an opportunity to avoid outright foreclosure. Basically, a borrower signs over the title (the “Deed”) to his home to his lender, and in return is supposed to receive a cancellation of his debt. For those borrowers with underwater mortgages (the mortgage balance exceeds the market price of the associated property), this is an incredible benefit, since it essentially allows them to walk away from their mortgages and leave the bank with the balance. However, it is also beneficial for delinquent borrowers whose mortgages are not underwater, since the deed will probably result in a higher sale price (and more leftover equity for the borrower after repaying the bank) than if the property had slipped into foreclosure.

You’re probably wondering: If this is the case, why would any sane lender make such an agreement? The answer is that foreclosure is costly, complicated, and just plain annoying. It can take six months (and even longer) for a foreclosure to be completed, from initiating proceedings to evict a delinquent borrower and sale of the property. During that time, the lender receives nothing from the borrower, and must in effect, pay property taxes and utilities itself. In addition, many spiteful borrowers will deliberately fail to maintain the property or even vandalize it, while waiting to be evicted.

In short, lenders have come to the conclusion that a Deed-in-Lieu will actually save them money, especially if a foreclosure is imminent. In fact, this realization is behind a new Citigroup program which provides for the borrower to live in the home for six months free-of-charge, and then offers them $1,000 in “relocation assistance” as long as the property is in move-in condition. Wells Fargo has a similar policy. Anyone with a Fannie Mae loan, meanwhile, has the right to remain in the home for up to one year following a deed-in-lieu agreement, and must pay market-rate rent (which is presumably lower than their mortgage payments were).

There are a few downsides to signing a Deed-inLieu. As with a foreclosure, your credit will be severely impacted, and you won’t be able to obtain a mortgage for at least a couple years. In addition, a handful of states have laws which allow lenders to go after borrowers for the remaining balance when an underwater mortgage is involved. Thanks to recent legislation, however, there are no longer significant tax consequences associated with the cancellation of a (underwater) mortgage, but as with any aspect of the tax code, certain conditions must be met.

Since a Deed-in-Lieu agreement must be entered into voluntarily, most lenders will not initiate one for fear that it makes it look like they are pressing to take control of a property. Thus, if you think you are eligible for, and would benefit from a Deed-in-Lieu, you should speak to your lender, and make it clear that you are doing so voluntarily. You can also cite HAFA if you think it would help.

Towards those ends, the Wyden-Gregg bill, which is currently working its way through the system, would either completely do away with, or scale back the deduction that many homeowners currently claim when filing their taxes. One proposal would impose a maximum income constraint of $250,000 on would-be filers, in order to address the concern that the deduction primarily benefits the wealthy. Another proposal would replace the annual tax deduction with a one-time homebuyer tax credit, amounting to perhaps $10K. Rest assured, however, since the bill doesn’t have much support – given current economic conditions – and it seems unlikely that the deduction will be phased out any time soon.

For the time being, then, you can still deduct interest on the first $1 million of mortgage debt, as well as all of your property taxes, for up to separate residences. (That’s $1 million all together, not each). In addition, you can also deduct interest costs on up to $100,000 for a home equity line of credit. For now, you can also deduct private mortgage insurance (PMI), but only if you bought your house  in 2007 or later. Property taxes – but not homeowners insurance – are also deductible. As with any aspect of the tax code, the mortgage interest tax deduction is much more complicated than you think, and there are a handful of conditions that must be met before you can claim it. The most important one is that you itemize when filing your taxes. For more information, refer to the IRS website, and review the flowchart below.

If you are in the process of buying a home (and obtaining a mortgage), you can use our Real Estate Tax Benefits Calculator to estimate the savings associated with deducting your mortgage interest. Basically, the calculator will multiply your marginal tax rate by your estimated annual mortgage interest (as well as PMI and property taxes) to determine how much you will save as a result of the deduction. Given the uncertainty surrounding this perk, however, you would be wise to treat the savings as a gift, and not try to apply all of it towards a more expensive mortgage.

Specifically, the new initiative will allocate $1.5 Billion to the handful of states that have witnessed 20%+ declines in housing prices: California, Florida, Nevada, Arizona, and Michigan. “There will be a formula for allocating funding among eligible states that will be based on home price declines and unemployment.  Eligible [Housing Finance Agencies] HFAs that would like to participate must submit a program design to Treasury.  Program designs must meet funding requirements under the Emergency Economic Stabilization Act of 2008 (EESA).” It seems then that the responsibility to develop specific solutions will rest ultimately not with the federal government, but with the organizations that receive the funds.

This initiative is a recognition that the housing crisis is composed of a number of local crises, rather than one cohesive nationwide crisis. There are disparities in housing prices, sales, delinquencies, even interest rates, that exist between states, sometimes even between counties. For example, the delinquency rate in Florida is much higher than in California, even though prices have fallen about the same in both states. Thus, it makes the most sense that unique relief programs be developed for each state, or even each locality.

A number of ideas have already been mooted, including “measures for unemployed homeowners, programs to assist borrowers owing more than their home is now worth, programs that help address challenges arising from second mortgages; or other programs encouraging sustainable and affordable homeownership.” In fact, unemployment, underwater borrowers, and second mortgages have all served as obstacles to national relief efforts, and it is important that now they can and will be taken into account when designing programs.

For example, unemployment has made it difficult for many borrowers with temporary loan modifications to obtain permanent modifications, since they couldn’t even make payments during the trial stage. As a result, the state of Pennsylvania developed a program that will lend $60,000 to unemployed homeowners for up to three years, to be used to pay their mortgage as they look for work. It’s unlikely that California could afford such a plan ["Pennsylvania's (plan) is great but we probably have more unemployed people in San Diego County than they have in Pennsylvania."], but it could work in a state like Michigan.

In addition, underwater borrowers have found it difficult to achieve either loan modification or refinancing.  “About one-third of California mortgage borrowers owe more than their home’s value. Californians in foreclosure owe an average of $140,000 more than their home’s value…But banks have fiercely resisted efforts to get them to reduce the principal owed on those underwater homes.” Finally, borrowers with second mortgages have found it difficult to convince one lender – let alone two! – that they deserve a modification. State plans could overcome these obstacles by rolling both mortgages together in the case of the latter, and work with lenders to reduce principal in the case of the former. Due to the local nature of this program, the precise terms would depend on local circumstances.

For those of you aren’t entirely clear, a mortgaged-backed security is simply a large portfolio of mortgages, bundled together for risk-management purposes, and sold to institutional investors. In theory, it’s a system that is designed to benefit everyone. Lenders are able to originate news loans freely without having to worry about holding them all on their balance sheets. Investors are happy because the MBS are structured such that a handful of individual defaults has minimal impact on the value of the whole portfolio. Borrowers, meanwhile, benefit in the form of lower interest rates.

In spite of the credit crisis, everyone is fighting to make sure that this system – or some semblance of it – remains in place. Currently, it is largely because of the interventions of the Fed and the government takeover of Fannie & Freddie that the market for MBS is even functioning. “More than 90 percent of home loans at the moment have some form of government backing, compared with about 30 percent at the peak of the housing boom.” In addition, the Fed’s $1.25 Trillion in purchases of MBS are keeping interest rates low, by “acting as a sponge, absorbing about $12 billion a week of what you might consider excess supply.” When either the government guarantees and/or the Fed’s purchases come to an end, surely the system will suffer a giant hiccup. The consensus is that when the Fed stops buying, rates could rise by as much as 1-2%, which could translate into more than $100,000 over the life of a typical mortgage. The Fed has attempted to allay these concerns by mulling an extension of the deadline of its asset purchase program for a second time (the original deadline was January 1, and the current deadline is March 31), but regardless, the end is near.

What will the new system look like? In form, not so much different from the current one. Namely, standards will be a lot tighter, That means higher credit score requirements, bigger down-payments, stricter documentation requirements, etc. From the standpoint of investors – who ultimately bankroll the mortgages – this means higher quality mortgages and greater transparency. As one such investor expressed, “I really want to know what the hell I’m buying.”

The government might also step in and beef up regulations. Lenders, might be required to begin holding a (larger) portion of mortgages that they originate on their balance sheets. “With some skin in the game, the theory goes, they would be more careful to ensure borrowers are screened properly. Another idea is for regulators to set a basic, industrywide level lending standard for things like down payments and borrowers’ debt levels.”

From the standpoint of borrowers, this translates into higher interest rates for prime borrowers, and even higher interest rates for everyone else.

In light of the Federal Government’s Home Affordable Modification Plan (HAMP), however, the tables have turned completely. Under the plan, lenders are incentivized (such that the costs to borrowers are theoretically nil) to modify loans for at-risk borrowers. Such modifications typically involve reduced interest rates, although some lenders have been known to cut the principal as well. Of course, it is now common knowledge that by almost every measure, this program has been an abysmal failure. Only 66,000 borrowers (as of Decemeber 31) have been approved for permanent modifications, far less than the 3-4 million that was initially touted.

In response, the government has taken to chastising lenders that aren’t aggressive enough in modifying loans, in the form of frequent “report cards.” Lenders blame borrowers, naturally, for not providing the necessary paperwork, and borrowers recriminate that the documentation demands are too onerous. The government’s latest attempt to remedy this discontent is to streamline the paperwork requirements so that borrowers need only to provide a request form for modification, proof of income, and authorization for the lender to check their tax history via the IRS. Despite these hurdles and the fact that delays of many months before being accepted (or rejected, for that matter) are common, the program still holds great appeal for borrowers. In fact, some borrowers are deliberately not making their mortgage payments, in a subtle attempt to demonstrate their financial plight to their lenders.

As a result of this shift and the simultaneous tightening of lending standards, it has become quite difficult to refinance a mortgage. The government has responded by unveiling a parallel program, this one aimed at refinancing. All loans that are owned by Fannie Mae and Freddie Mac (themselves “owned” by the government) are automatically eligible for refinancing. Even underwater loans – up to 125% Loan-to-Value – can be refinanced. Otherwise, the only option for those rejected for loan modification and desperate to refinance, is an FHA refinancing.

Given that mortgage rates are hovering around record lows, refinancing for many borrowers would achieve comparable cost savings to modification. One has to wonder, then, if after the expiration of HAMP and the return of the mortgage market to normal functioning (admittedly, this is an uncertain prospect) if the pendulum will swing back in favor of refinancing. With that possibility in mind, borrowers should think twice about deliberately skipping mortgage payments to increase their chances of modification, because such will also dent their chances of getting refinanced. At the same time, the fact that mortgage rates are projected by many to begin rising in 2010, the window on viable refinancing could soon close.

In short, it seems that for those of you who are genuinely at-risk of defaulting, keep talking to your lender about a loan modification. For everyone else, refinancing is probably still your best – and most realistic – option.

Speculation surrounding the fate of Fannie and Freddie has been building steadily over the last year. Some expect(ed) that the organizations would be broken up and sold to private investors. Others thought that they would be turned into fully public institutions, with explicit government support. The only consensus was that a return to their previous hybrid structures was unlikely. Rep. Barney Frank (D-Mass.), chairman of the House Financial Services Committee, cooled this speculation when he announced last week that, “The committee will be recommending abolishing Fannie Mae and Freddie Mac in their current form and coming up with a whole new system of housing finance.”

Of course, it’s unclear what this new system will look like, and even less clear when it will be implemented. That’s because while the Federal government has been active in the housing/mortgage market since the credit crisis (i.e. loan modification, Fed purchases of mortgage-backed securities, homebuyer tax credit, loan application/documentation reform, FHA mortgage assistance programs, etc.), not one of its initiatives has meaningfully addressed Fannie and Freddie, except for periodically allocating more cash to them.

Some commentators have already written off Fannie and Freddie as irrelevant, but that’s only because they have been (temporarily) been replaced by Ginnie Mae, which basically functions as F&F did before they were taken over by the government. In fact, the only mention that they have merited of late was in regard to shedding mortgage bonds from their portfolios (by forcing lenders to repurchase loans that were improper in hindsight), rather than accumulating more.

Whether we’re talking about Ginnie, Fannie, or Freddie, the idea is the same: the Federal Government remains an indispensable part – whether implicitly or explicitly – of the current system. Under any alternative system of financing, obtaining a mortgage would probably be more difficult, or at least more expensive (from an interest rate standpoint). However, the result of this could very well be to drive housing prices down further, in which case Fannie and Freddie would serve the same purpose in death as they did in life: to make home ownership more affordable and hence, widespread.

I’ll continue to pontificate in a minute, but let me first report the actual changes. They are as follows:

• New borrowers will have to have a minimum credit score of 580 to qualify for a 3.5% down payment. Those with lower scores will have to make at least a 10% down payment. The average credit score of FHA-insured borrowers is 693.

• Allowable seller concessions will be reduced from 6% to 3% of the sale price. The change is intended to discourage inflated appraisals.

• Buyers will have to pay an upfront mortgage insurance premium of 2.25% of the total loan amount, up from 1.75% now. A $150,000 mortgage would require a payment of $3,375, or $750 more.

While the new rules are largely self-serving (i.e. to help the FHA mitigate against bankruptcy, and having to solicit funds from Congress), they should also help consumers. Those of you with credit scores in the low 500’s are probably rolling your eyes at this, given the higher down-payment requirements and insurance premiums. But bear with me.

As the housing crisis made painfully clear, there are some borrowers who simply shouldn’t be eligible for mortgages. While enabling every borrower to potentially obtain a mortgage and purchase a house seems altruistic, it is actually the opposite, since it threatens the viability of the entire system. This is not a political issue, but rather a practical issue. Given the high rates of default associated with FHA mortgages, the FHA has no choice but to tighten lending standards. Failure to do so would risk its very existence. Those that are depending on the FHA for their mortgage would certainly agree that more expensive government loans are better than no loans at all.

It seems that these new rules are also intended to punish lenders. (As if to make this point, the FHA revoked the licenses of a handful of lenders the day before it was scheduled to announce the tightening of lending standards). Even today, too many lenders abuse the FHA insurance system by underwriting loans to un-credit-worthy borrowers at no risk to themselves. Such borrowers, for better or worse, will now be barred from the process, and those that are still able to participate can expect to pay for that privilege.

It’s worth pointing out that this development represents a window into the future of the government’s role in the mortgage market. While it probably didn’t intend to do so, the FHA has signaled that this unprecedented era of government assistance for mortgage borrowers could be coming to an end. Going forward, some of these programs will apparently be expected to pay for themselves, rather than operate permanently in the red.

Speaking of which, what are Fannie and Freddie up to these days?

Let’s get serious for a moment. A 203(k) is a HUD program that provides mortgage loans for the purchase of so-called “fixer-upper” properties. According to HUD,  203(k) mortgages serve a very important function because, “The purchase of a house that needs repair is often a catch-22 situation, because the bank won’t lend the money to buy the house until the repairs are complete, and the repairs can’t be done until the house has been purchased.”

Towards that end, the 203(k) allows the borrower to roll all of the costs of renovation into the mortgage. While these costs are theoretically uncapped, they must be estimated ahead of time. Further, it must be confirmed by an appraiser that the value of the home will increase at lease by these costs upon the work’s completion. In this way, those that might have otherwise been discouraged from buying dilapidated properties have an inexpensive source of financing (only 3.5% down, consistent with the FHA’s other mortgages).

There is also a new Streamlined 203(k) “Limited Repair Program, that permits homebuyers to finance an additional $35,000 into their mortgage to improve or upgrade their home before move-in. With this new product, homebuyers can quickly and easily tap into cash to pay for property repairs or improvements, such as those identified by a home inspector or FHA appraiser.”

The costs of these repairs, along with a “contingency reserve” of 10-20%, origination fees, and of course the purchase price of the property, are all rolled into the mortgage. Since it’s assumed that many of these properties won’t be of inhabitable condition until after the repairs are completed, the borrower also has the option of rolling 6 months of pre-payments (PITI) into the mortgage as well. Upon closing of the mortgage, the repair costs are deposited into an escrow. Withdrawing these funds can be tricky, however.

While FHA loans are effectively guaranteed by the government, they are originated and administered by private lenders. As one couple’s story illustrates, dealing with one’s lender is not always straightforward when it comes to the 203(k):

“As the contractors were hungry for work, we got started improving the property right away,” she said. “We had been told by our mortgage broker that we could expect the first draw against our $35,000 escrow 15 days after closing.”

As time passed, however, “we heard nothing from Bank of America, other then where to send our first mortgage payment,” she said.

For three months, the couple paid their mortgage, yet received no check for the work done so the contractors could be paid.

To pay for the work, “we have had to empty our savings and run up our credit cards,” she said. “We finally asked them to stop until we can find resolution with Bank of America.”

Unfortunately, borrowers who get the run-around from their lenders unfortunately don’t have much recourse, and can’t expect any help from the government. The best advice, then, is to make sure that the escrow is available to you start shelling out money for repairs. In fact, the raison d’etre of the 203(k) is to prevent the borrower from having to pay for repairs out of his own pocket. In hindsight, this couple would have been wise to heed this advice.

According to the latest figures, over 650,000 loans have entered the trial modification stage, during which point they must demonstrate their sincerity, eligibility, and capability, before they can be converted to permanent modifications. Specifically, they must make 3 payments under the new terms and submit certain documentation, that proves they are legitimately entitled to a modified loan. You would think that this wouldn’t be too difficult, but to-date, only 30,000 temporary modifications have been converted.

Naturally, there is no shortage of blame to go around. The government is blamed for not spurring more trial modifications (it originally estimated the pool of eligible borrowers at four to seven million). Lenders are blamed both for taking too long and for not granting increased leniency to borrowers, some of which are still seeing an increase in their monthly payments following modifications. Lenders counter that borrowers are also to blame, both for failing to make the required 3 payments under the trial modification and for not submitting the necessary paperwork.

Representative Jeb Hensarling’s assessment reflects what everyone is undoubtedly thinking: “Taxpayer-funded foreclosure mitigation programs have been an abject failure.” He and is leading the campaign to completely abolish the program. I’m partially playing devil’s advocate here, but perhaps it’s time to face the fact that this initiative was designed to fail. 25% of borrowers that received temporary modifications ultimately defaulted, while a handful of modifications have been handed to borrowers that weren’t even behind on making payments. Then, there are those that deliberately fell behind on their payments in order to receive payments, and those that are “naturally” behind by avoiding modifications because of the hit to their credit score that comes with the delinquency denotation reported to the rating agencies.

For better or worse, the program refuses to die; a new executive order prevents lenders from canceling temporary modifications “scheduled to expire before Jan. 31 for any reason other than property eligibility requirements.” Progressive Congressman, such as Barney Frank, are advocating alternatives, such as a program in Pennsylvania that makes low-interest loans to the unemployed that can be used to make mortgage payments. He is also trying to re-introduce a “cram-down” bill, that would give judges discretionary power to modify mortgages as they see fit. Finally, under pressure from the government, lenders have redoubled their efforts, in some cases bringing on more staff and opening new centers staffed exclusively to make loan modifications. Maybe there is hope after all…