President Obama’s plan to trim the rising pile of home foreclosures contains a comprehensive list of new ideas and old ones — an acknowledgment that there is no single solution to the housing crisis at the heart of the recession.
The plan applies $75 billion from the taxpayer-funded financial rescue package to help lenders lower borrowers' monthly payments and reach the administration's goal of keeping up to 9 million families in their homes.
The government also will commit $200 billion to buy up more stock in Fannie Mae and Freddie Mac to shore up the mortgage giant’s financial base, much the way the government injected money in the banking system in return for stock.
Another $50 billion would be allocated to increase the number of loans Fannie and Freddie can buy outright.
“We have been using a squirt gun to try to put out a forest fire in the mortgage market for the last two years. This looks like a howitzer,” said Howard Glaser, a former HUD official in the Clinton administration. “They're throwing everything at it. It's not an incremental approach. It's the first thing on the table I think that has any chance of showing a path to the bottom of the housing market.”
Now it just needs to work.
A lot depends on how quickly and widely the plan is embraced by lenders and the “servicers” who manage mortgage payments for the thousands of investors who hold an interest in the millions of loans that were pooled, chopped into securities and sold to banks and investment funds around the world.
“It may be very aggressive but it's going to take a long time for this to be implemented; it's not going to change things overnight," said David John, a senior research fellow at the Heritage Foundation. “It will probably slow foreclosures, but it will not be enough to by itself stabilize housing prices. And it's certainly not enough to fix the economy.”
Obama offered up the details of the plan in a speech in Phoenix, one of the nation’s most extreme examples of the real estate boom and bust that has lead the global economy into a deep recession. Beyond the specifics, the wide ranging plan is designed to provide an important psychological boost to the battered real estate industry.
“The overall biggest problem I see is just the confidence level of these buyers,” said Robert Hassett, a Scottsdale, Ariz., real estate agent. “The buyers are out there. They just seem to be searching for that bottom to come.”
The Obama administration is hoping that a multi-pronged, multibillion-dollar effort will help lay the groundwork for that bottom.
"In the end, all of us are paying a price for this home mortgage crisis,” Obama said in his speech. “And all of us will pay an even steeper price if we allow this crisis to deepen — a crisis which is unraveling homeownership, the middle class, and the American Dream itself.”
For the past year, the government has largely stayed out of the foreclosure mess, preferring to let bankers and borrowers work out solutions on their own. More aggressive proposals quickly faced strong political opposition on Capitol Hill and on Main Street to using taxes paid by one homeowner to help another at risk of default. Opponents also argued that “moral hazard” requires that lenders and borrowers who made bad decisions should suffer the consequences.
But that approach hasn’t worked. Of the hundreds of thousands of homeowners who have worked out new mortgage terms with lenders, as many as half find themselves “re-defaulting” on their new loans.
Some 1.5 million homes have been lost to foreclosure since the recession began 11 months ago, and another three millions are expected this year. Without aggressive measures, another 8 to 10 million foreeclosures are expected and could go higher if the job market continues to deteriorate.
The glut of foreclosed homes continues to push property values lower and leaves the housing industry mired in its worst recession since the 1930s. On Wednesday, the government reported that new home starts and applications for future projects plunged to record lows in January as all parts of the country showed big declines in building activity.
To stop the downward spiral of housing starts and home prices, the administration is focused on trying to help so-called “preventable” foreclosures. Those are homeowners at risk of falling behind in the their payments but could avoid foreclosure with a lower monthly payment. Many of those borrowers are paying substantially higher-than-market rates on loans that came with onerous interest “resets” that make them unaffordable.
To increase the number of loan modifications and improve the affordability of new loans, Obama is proposing a collection of “carrots” and “sticks” to get lenders and servicers to move more aggressively.
The carrots to lenders are even more generous than earlier proposals. Lenders and servicers would get thousands of dollars in bonuses for successfully modifying loans. The government would also share the cost of cutting monthly payments.
The “stick” in the plan is a proposal contained in several unsuccessful bills considered by Congress over the past year: to allow bankruptcy courts to modify terms of a mortgage — the only form of debt currently off-limits to judges. The hope is that more lenders will opt for the financial incentives of modifying a loan rather than take their chances with potentially more onerous terms ordered by bankruptcy judges. The Obama administration is proposing a "partial cramdown" in which only the principal in excess of current market value would be considered unsecured debt eligible for modification by judges.
Even if the plan works as designed, millions of homeowners will not be eligible. The plan doesn’t apply to investors. That's a potentially thorny issue for buyers at the height of the boom who claimed the home was owner-occupied, or who have since rented their home to make payments they could no longer afford.
The plan also won’t offer help to a homeowner who has lost his or her job and is unable to afford a new, lower monthly payment. Under the plan, lenders would take the loss on mortgage payments lowered to 38 percent of a borrower's income; the government would pay to subsidize a further reduction to 31 percent of income. But those with no income would not be eligible.
One of the thorniest problems many homeowners at risk of losing their home face is the inability to refinance to a lower rate because they owe more than their home is worth. Some one in five households is currently “under water” because of the slump in home prices.
Under current lending guidelines, homeowners can only refinance 80 percent of their home’s value — which for many won’t cover their existing mortgage. The government’s plan would raise that limit to 105 percent of the current market value.
For homeowners with loans worth more than 105 percent of the home's value — which some foreclosure specialists say is one of the biggest roadblocks to loan modification — lenders and servicers could still opt to write down principal, but the decision would be voluntary.
A new $10 billion insurance fund would help protect lenders against losses if home prices fell further after they refinanced 100 percent of current market value.
“The estimated cost to taxpayers would be roughly zero,” said Obama. “While Fannie and Freddie would receive less money in payments, this would be balanced out by a reduction in defaults and foreclosures.”
But taxpayers will be on the hook for the $75 billion spent to buy down monthly mortgage payments for those who qualify. Many homeowners, some of whom also are struggling to make payments, are furious at the prospect of seeing their taxes used to help pay their neighbor's mortgage. To help answer those criticisms, Obama said that all homeowners will benefit from the government’s effort to keep mortgage rates low.
“Millions of other households could benefit from historically low interest rates if they refinance, though many don't know that this opportunity is available to them — an opportunity that could save families hundreds of dollars each month,” he said.
The plan also includes some technical provisions to help untangle the legal morass created by the multitrillion-dollar wave of mortgage securitization at the height of the lending boom. Mortgage servicers have argued that even if they want to modify loans, they fear lawsuits from investors who would have to take less money. Getting those investors to agree on modified terms has been difficult.
To help break that logjam, the Obama plan spells out uniform guidelines for modifying a loan and then protects lenders and servicers from lawsuits. The guidelines include a standard formula for estimating the value of a home in a falling market. Now, each lender and servicer uses its own formula, which offers another opportunity for investors to challenge proposed loan modifications.
While the plan would require lenders accepting government “rescue” funds to use the guidelines, there are no requirements that they modify loans.