The GSEs are being pressured by the Obama administration to participate in the FHA short refi program, according to a report in the Wall Street Journal.

According to WSJ, only 61 applications were filed in the first three months and only three have been processed.

"The success rate is consistent with our expectations that the FHA short refi program in the current form is too complicated and is unlikely to succeed," explained analysts at Bank Of American Merrill Lynch. "We continue to hold onto this view."

The way the GSEs would be worked into the program would need them to buyout 120+ delinquent mortgages. They then would modify these loans under Home Affordable Modification Program or HAMP and if the mortgage becomes performing again, then the loans would be eligible for a Federal Housing Administration (FHA) short refi.

The GSEs, explained BofA Merrill analysts, have the option to refinance the loan under the FHA short refi program and offload the risk to FHA after taking some principal loss. "We believe this workflow is convoluted and expect this program to be even less successful than the original FHASecure and H4H programs," analysts said. "Also, GSEs can fund these reperforming loans at very attractive rates and have no incentive to take higher losses."

For the agency MBS market, if GSEs were to agree to participate in the program, it would not mean that current loans would be bought out of agency pools for modification.

However, the key risk for agency MBS investors is that the roll rates from current to delinquent state may go up because of the moral hazard associated with principal forgiveness, according to BofA Merrill analysts.

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