With some two million homeowners facing higher monthly payments that many won’t be able to afford, conditions in the housing industry easily could get worse before they get better. A lot depends on how homeowners, lenders and investors respond as they try to head off defaults and foreclosures before they happen.
So far, the complexity of the problem has hampered effective solutions.
“I think there is a dearth of good ideas,” said Mark Zandi, chief economist at Moody’s.com. “This is a very difficult problem to tackle for policymakers. There is no magic bullet.”
One proposal — announced this week by Treasury officials after a similar plan was unveiled last month in California — would freeze interest rates on adjustable mortgages for borrowers who are currently keeping up with their payments. The hope is that by refinancing these loans, the wider damage to the housing and lending industries from bad loans and foreclosure sales can be minimized.
“There is value in these loans,” said Sheila Bair, chairwoman of the Federal Deposit Insurance Corp. “They can’t perform at the reset (rates) because those resets were never realistic. They can perform at the starter rate.”
Bair, one of the early proponents of freezing rates, said more than 80 percent of subprime adjustable-rate loans are current.
“If they’re current, that would suggest they’re viable,” she said.
Keeping those loans viable means modifying them before borrowers fall behind. Though lenders have begun reviewing loans, the pace of refinancing has been far slower than the frenzied lending that led up to the housing bust.
“What you have right now is an industry that is under siege and doesn’t really know what to do,” said Ira Rheingold, executive director of the National Association of Consumer Advocates, which represents lawyers who work with homeowners to head off foreclosure.
One of the biggest problems is that many homeowners at risk of default qualified for loans during the easy-lending boom when underwriting standards were much more lenient. Those who got their original loan without providing proof of income will now have to do so when they ask for new loan terms. Many of them may not qualify.
Even if an underwriter can be convinced that a borrower is a good credit risk for a new fixed-rate loan, falling home prices have introduced another major wrinkle. If the loan is bigger than the value of the house securing it, investors who bought the loan will have to agree to take a loss. Without broad guidelines for those negotiations, each mortgage has to be handled one loan at a time — often with multiple investors on the other side of the transaction.
Loan servicers — who collect payments from borrowers on behalf of investors — have some latitude to modify loans directly. But many are afraid of getting sued by investors for any losses that might result from cutting the interest rates.
“If the servicer takes too many mortgages and adjusts them, and the investor is getting punished, (the investor) is going to say, ‘Well I’m not going to give up all this. Somebody’s going to have to share this burden,” said Michael Zoretich, vice president of CK Mortgage in Brookings, Ore.
The Treasury-backed "Hope Now" program aims to speed the process by identifying the most viable borrowers and encouraging lenders and servicers to help them arrange new loans. But some have argued that the plan doesn't go far enough. For one thing, the guidelines are voluntary.
“There’s no stick,” said Zandi. “The Treasury is trying to broker a deal. It’s not putting the Treasury on the line. It’s not saying, ‘I’ll make whole the investors. I’ll do whatever it takes to make it work.'”
One proposal making its way through Congress would give homeowners a bigger stick — by changing the bankruptcy law to allow courts to set new loan terms. (Current law bars judges from changing the terms of a primary mortgage.) The Senate Judiciary Committee is scheduled to hold hearing on the proposal Wednesday.
Proponents of the idea say the change would alter the dynamics of negotiations among borrowers, lenders and investors — even before the borrower got to bankruptcy court.
“Now the thinking changes (for the lender),” said Rheingold. "'If we do nothing, (the homeowner) may go to bankruptcy court and modify the loan in terms that are worse to us than if we just worked it ourselves.’ So it may move the ball in a direction to create the incentives necessary for the industry to do something.”
Critics of bankruptcy reform say the change could have a chilling effect on new lending, because lenders could no longer count on original loan terms surviving a bankruptcy challenge.
“We need people to be comfortable making home mortgages,” said Chris Mayer, a Columbia University economist. “If I were a lender right now looking at making a new loan, I would be pretty nervous.”
A lot depends on whether the housing recession deepens and spreads to the wider economy. If the situation worsens, the prospects for changing the bankruptcy law improves, according to Jaret Seiberg, an analyst at Stanford Research in Washington who is following the progress of mortgage reform proposals on Capitol Hill.
“At this point, if the industry cannot come to terms on a freeze plan that applies broadly to subprime borrowers, I think it is going to be difficult to stop mortgage bankruptcy reform,” he said.
That still leaves the problem of expanding the pool of money for new home buyers in a mortgage market that is badly broken. Money for new loans has dried up for all but the most creditworthy borrowers. But debate over reforming the government’s role in mortgage lending was well under way long before defaults and foreclosures began rising this year.
One piece of the debate centers on guidelines for mortgages insured by the Federal Housing Administration, which has much stricter underwriting standards than used by many lenders during the height of the boom.
“The reality is over the last few years everyone in the market has pulled out of FHA because subprime was a much easier product to underwrite,” said Nicholas Bratsofolis, chairman of New York-based mortgage bank Refinance.com. “You could do volume you could put people in the product who could just state their income.
Now that investor funding for subprime loans has dried up, Congress is looking at making it easier to underwrite FHA loans. Opponents of loosening FHA guidelines warn that it could simply introduce more risk to government-backed loans. But with other borrowing options limited, reform proponents have argued that FHA guidelines have to be broadened.
“If you need to come up with a replacement product for subprime there's only one place to look at, and that’s FHA,” said Siebert. “That’s why FHA reform is so important."
Congress has also looked at proposals to give government-sponsored lenders Fannie Mae and Freddie Mac authority to write more — and bigger — mortgage loans. These giant entities provide pools of mortgage capital by selling off loans to investors, who assign them lower risk because of the belief that the government will stand behind loans that go bad.
But the mortgage meltdown has taken its toll on both companies. Fannie Mae reported Tuesday it was cutting its dividend and selling $7 billion in stock to shore up its finances. Last month, Freddie Mac announced it would sell $6 billion in stock to help offset an expected rise in loan losses.
"The problems have gotten so big that Fannie and Freddie are engulfed in them," said Zandi. “Their capital (is) constrained. So even if you gave them the authority, I’m not sure they could really execute at this point.”
Zandi believes that eventually the government will have to set up what amounts to a mortgage clean-up fund, similar to the Resolution Trust Corp. that was created to buy up loans after the collapse of the savings and loan industry in the late 1980s. Under such a plan the government would buy up mortgages at risk of default — at a steep discount — and work out new terms with homeowners.
But the idea of using taxpayer dollars to head off foreclosures still faces opposition. Many taxpayers who believe they acted responsibly are loathe to see their money used to help borrowers who are in trouble, based on mail received by msnbc.com.
“In most cases both lender and borrower are getting what they deserve,” wrote Lee Goodridge of Marion, N.Y. “Maybe it's about time these lenders stopped scheming and scamming, and borrowers start living within their means instead of trying to outdo the Joneses, let alone keep up with them. Why should the government be doing anything with this?”
“When will people take personal responsibility for their actions?” wrote Greg Gagola of Tallahassee, Fla. “Borrow what you can pay back. Read your contract. If you do not understand your contract, hire a real estate lawyer. We as a nation need to take responsibility for what we do.”