With the battered housing industry at the heart of the economy’s slide, Congress and the Obama administration have identified foreclosure relief as a top priority. But the problem has been stubbornly resistant to quick fixes.
After a year of failed efforts, Congress and the new administration are considering more aggressive measures, including a possible change to bankruptcy law. Homeowner relief could come as part of a new economic stimulus plan, a revised financial system bailout program or as a standalone measure.
So far, progress remains painfully slow. More than 3 million homes have been lost to foreclosure since the housing bubble burst. Roughly one in 10 homeowners with mortgages are either in foreclosure or more than 30 days late in payments — the highest delinquency rate on record.
Without more aggressive measures, another 8 million to 10 million foreclosures are forecast over the next four years, according to Credit Suisse. That amounts to roughly one in six households with a mortgage.
“It is simply mind-boggling to me that (Congress and the White House) have moved so slowly to address this issue,” said John Taylor, president of the National Community Reinvestment Coalition, which has been lobbying for foreclosure relief.
Congress and the incoming administration are taking a multipronged approach to foreclosure relief.
"Accelerating foreclosures is obviously, in my view, the huge driving problem right now,” said Elizabeth Warren, a Harvard law professor appointed by Congress to chair a panel overseeing the financial bailout. "Until we think in a more comprehensive way, we can't create solutions that will really make a difference," she told Congress last month.
Many of solutions tried so far have been stymied by the legal morass created by the modern mortgage.
In past recessions, it was not uncommon for lenders to work out more affordable terms with borrowers who had fallen on hard times. Bankers often prefer to cut their losses by lowering monthly payments and stretching them out over a longer term rather than bearing the cost of foreclosure. But the complex system of financing the recent housing boom — which was based heavily on the pooling of mortgages that were then sold to thousands of investors — has hopelessly complicated a once fairly simple renegotiation between lender and homeowner.
Multiple classes of investors, each with different claims on the same mortgage, often have conflicting interests. Some will do better with a loan foreclosure while others would profit by keeping the loan performing. Some contracts setting up these pool pay loan “servicers” — the companies that manage mortgage payments to investors — more generous payments for loans in foreclosure and offer little financial incentive to undertake the more costly process of modifying terms.
“You have got to have the investor or their representatives come to the table motivated to do something,” said Taylor. “And that’s currently what we don’t have.”
To break the logjam, Congress is considering various proposals, including both "carrots" and "sticks."
One of the "carrots" is included in a proposed revision to the $700 billion bailout of the financial industry known as the Troubled Asset Relief Program, or TARP.
Now, as Congress prepares to authorize the second $350 billion in spending for the program, Democratic leaders are pressing for changes that would expand beyond the banking industry, which has been the primary beneficiary of the program. A House Committee heard testimony Tuesday on revisions that would commit between $40 billion and $100 billion of TARP funds to various foreclosure relief measures.
One proposal would expand an FDIC program aimed at standardizing the loan modification process and paying mortgage servicers a fee for every loan they modify. To cap monthly payments at no more than 31 percent of a borrower’s income, loan servicers could extend the loan to 40 years or defer some interest until the borrower sells or refinances their home. The measure would also provide mortgage servicers some protection against investor lawsuits claiming a loan modification lowered their returns.
The TARP revision also could include changes to the Hope for Homeowners program, which provided $300 billion in guarantees to help lenders refinance troubled borrowers into FHA mortgages. Lenders balked because the program was too costly; changes in the law are expected to make the plan more attractive.
Congress also is considering various proposals as part of a planned $800 billion economic stimulus program, including tax cuts promoted by the home building industry for home buyers. That could include tax credits for all homebuyers, not just first-timers, of $7,500 or more. Mortgage interest would be deductible even for taxpayers who don't itemize; tax incentives may also be given to owners who rent out vacant properties.
The most controversial foreclosure relief proposal — and the biggest "stick" being considered — involves changing the bankruptcy law to allow courts to modify terms of first mortgages on primary residences. (Those are the only form of debt currently excluded from the bankruptcy process.)
First proposed over a year ago, the latest proposal would require borrowers to contact their mortgage lender 10 days before filing for bankruptcy to give the two sides time to work out a modification. If the lender doesn’t make an offer, a judge could then adjust the loan balance to fair market value, cut the interest rate and extend the loan as part of a court-ordered five-year payment plan. There’s no guarantee, however, that a foreclosure could be prevented if the mortgage balance greatly exceeds the homeowner's ability to pay it down.
This so-called "cram-down” provision is strenuously opposed by the lending industry, which argues that the new risk that a loan will later be modified by a judge will increase the cost of borrowing. Some financial analysts caution the move could also make mortgages harder to finance.
“Investors outside the U.S. will now view the U.S. mortgage market as riskier and therefore they may be willing to commit less capital to it,” said Jaret Seiberg, an analyst with the Stanford Group.
But that view is disputed by some economists. Adam Levitin, a professor at Georgetown University Law Center, say his research comparing mortgages on single-family homes, which are excluded from bankruptcy court revisions, and multifamily homes, which aren’t, showed the difference in interest costs amounted to a fraction of a percentage point.
“There was a statistically significant impact, but it was small,” he said. “I would expect to see that impact borne by the highest-risk borrowers, and that’s very good policy. It would inject a little prudence into the mortgage lending process.”
Though it was defeated twice in the last Congress, the measure got a major boost last week when Citigroup agreed to support the proposal, with some modifications. (One key change would restrict the provision to existing mortgages, preserving the bankruptcy exemption for new first mortgages.) The National Association of Home Builders, also a staunch opponent last year, has signaled it would consider supporting some form of the provision.
Congress also is looking at additional measures aimed at reducing mortgage rates to spur home buying, including providing an explicit government guarantee and raising limits on conforming loans issued by Freddie Mac and Fannie Mae. But those measures offer little relief to the roughly one in six homeowners whose home’s value has fallen below their mortgage balance.