Call it what you will — a bailout or a loan. The Federal Reserve's actions to save Bear Stearns from collapse have intensified debate over whether the government also needs to do more to prevent millions of homeowners from losing their homes.
So far, the White House has opposed the idea of using taxpayer dollars to help homeowners struggling under mortgage debt.
But with the mortgage meltdown threatening to grow into a wider economic calamity, plans for a more aggressive approach are beginning to take shape on Capitol Hill. Under some of the proposals the government would get some of the future appreciation of a home in turn for its role in refinancing.
“The problem at its heart is one of stopping the decline in home prices,” said Bill Gross, chief investment officer at PIMCO, the giant bond fund manager. "We have an asset deflation of significant proportions under way here. And to let a home in Des Moines drop to 80 cents on the dollar through foreclosure or otherwise is to mark down every other house on that block, the city and the country.”
To date, the government’s primary response to the rising tide of foreclosures has been the Hope Now Alliance, a voluntary consortium of lenders and community groups set up to streamline communication between borrowers and their lenders. Though Hope Now officials say hundreds of thousands of homeowners have been helped, many have been left facing bankruptcy or foreclosure as their loans adjust upward to monthly payments they can’t afford.
Uncertainty over future losses from distressed loans played a major part in this week's collapse of Bear Stearns. If unchecked, ongoing problems in the mortgage market threaten to cause even wider damage to the housing market and the economy, said Alan Blinder, a Princeton University economist and former Fed vice chairman, who is working on a foreclosure relief plan of this own.
“This problem that started in the mortgage market has now spread over the months that have elapsed from August to now into — not quite every nook and cranny of the credit markets — but most of them,” he said. “And it’s threatening to begin moving like a blob into all the other markets. If and as those markets stop functioning well, the economy gets seriously imperiled. And that goes to most people’s jobs and incomes. So this is really about preventing a bad situation from getting a lot worse.”
All of which has helped blunt some of the opposition in Congress and the White House to a wider government response, said John Taylor, president of the National Community Reinvestment Coalition, which has drafted a plan to head off defaults and foreclosures called Help Now.
“I think (opponents) are recognizing that there needs a more aggressive approach if they’re going to revive this worsening economy,” he said.
The pipeline for new mortgages has been battered by losses already booked by investors who bought securities backed by now-distressed loans. Until those investors regain confidence in the quality of new loans, funds for refinancing or new home purchases will be remain costly and difficult to find.
“We're in a problem where investors are on strike, having bought what they shouldn't have bought,” said Rep. Barney Frank, D-Mass., chairman of the House Financial Services Committee. “And now they don't want to buy what they should buy.”
Frank has proposed legislation to end that "investor strike" by authorizing the Federal Housing Administration to provide up to $300 billion in loan guarantees for new mortgages to replace old loans gone bad. Sen. Christopher Dodd, D-Conn., who heads the Senate Banking Committee, introduced the Hope for Homeowners Act.
While they have some significant differences, the plans share some common ground. The general idea would be for the government to identify problem loans and ask the investors who hold them to book a loss that, in many cases, they’ve already taken.
The government would then sell the loans back into the credit markets at a lower price, while offering new, more affordable loans to the borrowers. The new loans would reflect the true, current value of the home and give homeowners a chance to begin building equity again.
The goal of all these proposals is to break a logjam that has resulted from the "securitization" of millions of home loans that have been bundled and sold off to many different investors, making it difficult to renegotiate when they go sour.
“If the government were to temporally acquire these loans, they’re now the investor," said Taylor. "They turn to the servicers and say, ‘Restructure and modify this loan, but use standard underwriting criteria and make sure it matches the borrower’s ability to pay.’”
So far, proposals to replace unsustainable mortgages with loans that homeowners can afford have been thwarted by the political backlash to putting taxpayer dollars at risk in a government “bailout” of borrowers. Following the Fed’s recent $30 billion loan guarantee to save Bear Stearns from collapse, proponents of these plans to say it’s only fair that both sides of these flawed mortgages should be helped.
The proposals seek to overcome that opposition in three ways. In general, investment properties and second homes would not qualify for new loans. Mortgage lenders and investors who bought into mortgage pools now facing defaults would have to take losses.
Borrowers also would be required to turn over some of the future appreciation in the value of their homes to pay back the government. The Help Now proposal, for example, would give the government a small lien on the home, payable when the home is sold or refinanced. By selling those liens into the secondary market, the government could divest its stake long before the home was actually sold or refinanced.
Opponents of wider government relief efforts also argue that many homeowners who are current on their loans deserve a break. To help overcome that issue, Blinder is proposing that homeowners who seek relief should be barred from taking out second mortgages or home equity lines and, perhaps, would have to agree to limits on credit card debt.
“The idea is to address the perfectly legitimate fairness complaint,” Blinder said. “And secondly to reduce the incentive for everyone to run to the government by putting some somewhat onerous terms on them — onerous enough that if you’re not really in trouble you’re not going to be attracted by this.”
Some basic issues still need to be resolved in reconciling the proposals. One is the question of whether loans would be bought by a federal agency and, if so, which one. Under Dodd’s bill, the government wouldn’t take ownership of the loans; bad paper would be marked down and paid off with new, more affordable loans. An FHA guarantee would sweeten the deal for new investors, and homeowners would pay the premiums for that insurance.
It’s also not clear whether the solution requires the creation of a new entity, similar to the Resolution Trust Corp. set up in 1989 to clean up the savings and loan industry at a cost of hundreds of billions of dollars. Some opponents balk at the idea of creating yet another federal bureaucracy.
Others say it would take too long: By the time a new agency is created, funded and staffed, it would be too late for many homeowners and would do nothing to stop the downward spiral in home prices as those foreclosed homes are dumped onto an already-glutted market.