February 21, 2008
A New Report by Wharton Associate Professor of Real Estate Todd Sinai
By: Todd Sinai, University of Pennsylvania

EXECUTIVE SUMMARY
Various programs have been proposed or enacted to address the so-called “subprime crisis.” These programs may help some borrowers, but they do not bestow these benefits equitably. Some reward those who made riskier decisions over those who made prudent decisions, exclude those who live in states that experienced an early economic downturn, benefit those with high incomes at the expense of others, and spread the costs of the program among all taxpayers or future borrowers – regardless of whether they benefit from the proposals.

Programs that would freeze or reduce interest rates, such as the American Securitization Forum’s Framework for Loan Modification announced in December 2007, often leave risk-taking subprime borrowers in a better position than if those borrowers had made a less risky decision in the first place. For example, freezing the teaser rate on subprime ARMs or refinancing other subprime borrowers into lower interest fixed rate loans will leave such borrowers in better positions than they would have been under the loans they originally obtained. In fact, they will be better off than those who made more prudent decisions such as taking out fixed rate loans initially or borrowing smaller amounts.

Differences in foreclosure rates among states are due to exogenous economic forces and not borrower or loan characteristics; for example, prime loans are defaulting at the highest rate in the same states where subprime defaults are highest. Policies that deny benefits to households in delinquency or foreclosure disproportionately exclude those who were unlucky enough to live in the states that experienced the worst of the current economic downturn.

The benefits of borrower relief programs will be highly concentrated geographically, but the costs will not. Federally mandated programs will be funded by taxpayers in all 50 states or through increased costs of future borrowing, but the benefits of the programs will accrue primarily to just some homeowners in some states, particularly California, Florida, New York and Texas.

Programs to increase the conforming loan limit, including the Economic Stimulus Act of 2008, raise questions of equity and increase the risk borne by Freddie Mac and Fannie Mae. High-value loans are concentrated geographically, with approximately half of all loans higher than the current limit originating in California. The benefits of increasing the loan limit will affect few areas outside California, New York, and Washington DC. In addition, given the size of the monthly payment required on a loan large enough to exceed the existing limit, raising the conforming loan limit will, according to calculations performed by the OFHEO, help only households with annual incomes of $129,000 to $180,000, rather than low income or working class families.