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HARP - Phase II – Another Baby Step• While fewer than 1 million borrowers wereable to refinance through the initial HARP, theFed estimates that 4 million borrowers appear tomeet the basic eligibility for HARP refinancingunder changes announced 24 October 2011.Chart 1: Share of Borrowers with NegativeEquity by Mortgage Rate Segment• FHFA is providing incentives for borrowersto refinance into shorter-term loans by“eliminating certain risk-based fees forborrowers who refinance into shorter-termmortgages”.• We estimate the maximum number ofeligible households to be around 4.5mn, theactual increase is likely to be far lower, around800,000 to 1mn.• HARP reforms could be more beneficial inthose cities and states where the proportion ofdeeply underwater borrowers is much largerthan the national average.• Overall, we consider the FHFA initiative tobe a positive, albeit small, step in the directionof reducing the structural problems in the UShousing sector. But other policy initiatives arealso clearly neededOn 24 October 2011, the Federal Housing FinanceAgency (FHFA), along with Fannie Mae and FreddieMac, announced changes to the Home AffordableRefinance Program (HARP) that are designed tomake it easier for underwater homeowners torefinance their mortgages at current, lower interestrates. The original HARP programme, which waslaunched in 2009, targeted borrowers with LTVsbetween 105% and 125% and has enabled justunder 900,000 borrowers to refinance their loans.Addressing existing impedimentsWhile fewer than 1 million borrowers were able torefinance through the initial HARP, the Fed estimatesthat 4 million borrowers appear to meet the basiceligibility for HARP refinancing. At a recent FederalReserve housing market forum, Governor Duke listedfour possible impediments to greater penetration byHARP: (i) upfront fees that are added to therefinancing costs of loans that are judged to havehigher risk characteristics, such as high loan-to-valueratios; (ii) put-back risk that the loan originator willhave to repurchase the loan from the GSEs becausethe underwriting violated GSE guidelines; (iii) holdersof junior liens refusing to allow their loans to remainsubordinate to a proposed new refinance loan; andSource: CoreLogic, Market Rate = 5.1% as of Q2(iv) mortgage insurers not agreeing to re-underwritetheir policies.The reforms to HARP will increase the reach of theprogram by directly addressing the first twoimpediments: risk-based fees should be reduced oreliminated, and mortgage originators will be relievedof put-back risk. Eligibility will also be extended tohouseholds with LTVs above 125%. To qualify forrefinancing, borrowers must have their loans sold toeither Fannie Mae or Freddie Mac on or before 31May 2009, be current on their mortgages (no latepayments in the past six months and nor more thanone late payment in the past twelve), and haveadequate income.Encouraging borrowers to shorten the termFHFA is providing incentives for borrowersto refinance into shorter-term loans by “eliminatingcertain risk-based fees for borrowers who refinanceinto shorter-term mortgages”. Mortgage rates tend tobe less for shorter-term mortgages. In fact, thespread between 30 Year and 15 Year Freddie Macfixed rate has widened significantly this year and isabout 2 standard deviations above the historicalmean (Chart 2). However, reducing the term of theloan to get a lower mortgage rate will result in asignificantly higher monthly payment. For manyunderwater borrowers, that might not be a viableoption, regardless of attractive incentives.Macroeconomic effects are not materialPrecisely estimating the rise in refinancing that thereformed HARP will unleash is difficult. However, wecan identify realistic upper and lower bounds forrefinancing. We estimate the maximum number ofeligible households to be around 4.5mn. We arrive atYelena Shulyatyeva 27 October 20111Market Mover8www.GlobalMarkets.bnpparibas.com