By John W. Schoen Senior producer
msnbc.com
updated 8/31/2007 7:08:42 PM ET 2007-08-31T23:08:42
ANALYSIS

The measures President Bush outlined Friday for dealing with the ailing mortgage market are just the beginning. When congressional Democrats return from their summer break, the list of proposals addressing how far government should go to help borrowers who got in over their heads will likely get longer — and the debate about how to pay for it will likely get louder.

Long before the mortgage market melted down this summer — spreading investor anxiety throughout the global credit markets — Congress and the White House already were locked in a debate about reforms that would expand the government’s role in it.

Now, as foreclosures and late payments have spiked, these reforms have taken on a new urgency. Some two million homeowners with adjustable mortgages will face higher rates — and payments — over the next year. Shifting market conditions have left many of them with more debt than they can carry — but they are unable to refinance or sell their homes without taking a big financial hit due to falling home prices and steep prepayment penalties.

The Federal Housing Administration set up after the Depression guarantees mortgage payments for some borrowers. Fannie Mae and Freddie Mac bundle loans that conform to lending standards and re-sell them to investors. While not directly backed by the government, these loans are considered less risky for investors, which helps lower the rates borrowers pay.

Bush stopped short of offering direct aid to mortgage borrowers facing default or foreclosures. Instead, Bush proposed that creditworthy borrowers — some of whom are now stuck in loans that are re-setting to higher monthly payments they can’t afford — be allowed to refinance with an FHA-backed loan.

The White House estimates that roughly 80,000 homeowners fall into that category — a relatively small portion of borrowers who are having trouble paying their loans. Video: Bush official on mortgage mess

Bush also proposed that borrowers who are able to negotiate a new loan with a lender who forgives part of the debt should be exempt from taxes on the difference. Currently, the tax code treats forgiven loans as income and subject to tax. Democrats have proposed a similar measure.

But Democrats also have made proposals that go beyond what Bush announced Friday, aiming to help repair the damage done by years of reckless lending, outright fraud and borrowers taking on more debt than they could afford. More than 100 lenders have been forced to close their doors, and the mortgage market has tightened quickly, making it much harder for some home buyers — especially those just starting out — to get a loan.

“At the moment the problem is that there is no credit or very high cost credit for about half the mortgage market,” said Mark Zandi, chief economist at Moody's Economy.com.

Bush made clear that he doesn’t support spending tax dollars to try to expand the pool of money available to borrowers.

“The government’s got a role to play, but it is limited,” Bush said. “A federal bailout of lenders would only encourage a recurrence of the problem.”

Democrats have proposed additional measures including expanding limits on the total lending authority of Fannie Mae and Freddie Mac, along with an increase in the size of individual loans. The current cap for so-called “conforming” loans is $417,000; proponents of lifting the cap argue that home prices in many of the hardest-hit housing markets far exceed that amount.

Supporters of FHA reform also are pushing to raise the limits for FHA-insured loans, allowing borrowers to put no money down and expanding the insurance program to include riskier borrowers, who would pay higher premiums.

Some Democrats have also proposed spending government money to help nonprofit community groups that help refinance loans for people facing foreclosure.

Republicans have opposed FHA reforms and expanded lending authority for Fannie Mae and Freddie Mac on the grounds that these moves could increase the risk to taxpayers if FHA-loans go bad or the government-sponsored agencies get into financial trouble. But the ongoing problems in the mortgage market give Democrats a political advantage when they return to Capitol Hill to complete legislation.

And though the White House was attempting to get out in front of the issue Friday, Bush’s proposal don’t go far enough to head off more sweeping measures proposed by Democrats, according to Greg Valliere, chief strategist at the Stanford Washington Research Group.

“It’s a lose-lose for Bush,” he said. “He’s antagonized conservative activists who feel that he’s a least put his toe in the water for some kind of bailout, however modest. At the same time he certainly hasn’t gotten ahead of the Democrats. (Sen.) Hillary (Clinton) is talking about a $1 billion bailout fund, and (Senate Banking Committee Chairman) Chris Dodd is talking about forcing Freddie and Fannie to put more in their portfolios. So the Democrats are way ahead of Bush on this."

Still, it remains to be seen whether Congress can move quickly enough to prevent the mortgage meltdown from spreading to the wider economy, increasing the risk of an economic recession. Recent data suggest that isn’t happening — yet.

In the meantime, the financial markets are ultimately looking to the Federal Reserve to blunt the impact of the rise in foreclosures and the damage inflicted on the housing market and the economy.  That point was underscored Friday when Fed Chairman Ben Bernanke pledged to act “as needed” to bolster the economy — in a speech concluded just moments before Bush’s remarks.

"At the end of the day, the Fed has the most powerful of weapons out there,” said Diane Swonk, chief economist at Mesirow Financial. “It's the one that's the most poised to be able to use it quickly.”

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