Foreclosure Crisis Plan Coming Down the Pike
By Susan Ozawa
February 17, 2009 - 6:02pm ET
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According to Geithner’s announcement last week the following will be pursued to address the foreclosure crisis:
1.) measures to reduce the interest rates on mortgages using TARP funding,
2.) the Fed will continue to buy Government Sponsored Enterprise (aka GSEs, e.g. Fannie Mae and Freddie Mac) issued mortgage backed securities (MBSs are bundled securities made up of mortgages). The Fed will also buy debt. Both will be funded by increasing the original Treasury funded facility by $100bn from $500bn,
3.) $50bn will be used to prevent foreclosures for owner-occupied middle class homes,
4.) a set of mortgage modification guidelines will be devised as standards for government and private programs (although it’s not clear if these will be binding) and
5.) for outstanding mortgage foreclosure relief programs, modifications will be allowed for a greater number of borrowers.
Taking them in order:
1.) Measures used to reduce the interest rates on mortgages could very well involve buying long-dated Treasuries which is an indirect way at creating lending floors (by pushing down the yield which is used as a benchmark for mortgage rates) and also distorts the bond market and expectations on the dollar and thus on investment in dollar denominated instruments. A more direct way to do this has been floated, namely for the government to buy new mortgages from private issuers at a targeted rate. Both proposals would primarily encourage refinancing which could stop some foreclosures.
2.) Underwriting GSE issued MBS that would otherwise not be by the market led to our moral hazard problem with the GSEs originally. Going forward, the terms of the loans should reflect sound origination (common sense underwriting practices) and the MBS market should be allowed to contract. $600bn also might not be sufficient to clean up the system comprehensively. The benefit of this tack is only that the government is incentivized to modify the loans on terms that are actually reasonable to the borrower once we’re left holding them.
3.) It is unclear how the $50bn will be used to prevent foreclosures for owner-occupied middle class homes, but if he will be taking up recommendations circulating these funds might target servicers to grant them incentives to modify the principals and terms of distressed loans. More direct assistance to homeowners would be the government declaring modifications mandatory; the lenders would be let off the hook for the original amount and servicers would collect what could reasonably be paid. (Many contingents would be satisfied with the original Bair proposal.) Another idea was floated, in Fort Myers. “Obama outlined an arrangement in which banks would accept lower payments from homeowners in return for an equity stake once housing prices recover,” which I find to be asymmetric given the gains to the originators and those who sold the MBSs would not be encroached upon, but more to the point, it makes default more attractive to the borrower.
4.) Mortgage modification guidelines are absolutely necessary but would be most effective if they were binding, not recommended standards. Self-regulation and incentives will not solve this problem systemically by relying on voluntary writedowns.
5.) Mortgage writedowns should be harmonized and mandatory for all homeowners subject to a means test against outstanding debt payments particularly for mortgages that are underwater.
Other good ideas:
Reward Good Mortgage Underwriting with TARP Funds
At the Thinking Big Thinking Forward Conference, February 11, Michelle Collins, Senior Vice President of Mortgage Lending at Shore Bank highlighted the fact that as a responsible lender ShoreBank did not issue one subprime loan. She stated however that currently her clients were suffering and indeed the mortgage crisis had spilled over into ShoreBank’s pristine portfolio. The criteria they use to deny new loans, 1.) insufficient income (affected by the larger job market contraction) and 2.) insufficient collateral (affected by the housing bubble bursting reducing these values) have stifled their ability to issue sound new loans. She identifies ShoreBank’s need for governmental support and makes the case that other local and community banks which have solid histories of common sense underwriting should be the first candidates for governmental assistance through TARP.
Dean Baker’s “Right to Rent” Plan
Legislation embodying this idea, H.R. 6116--110th Congress (2008): Saving Family Homes Act of 2008, was introduced to Congress May 21, 2008, sponsored by Rep. Raul Grijalva [D-AZ], Cosponsors, Rep. Dennis Kucinich [D-OH] and Rep. Edward Pastor [D-AZ]. The bill,
[g]rants eligible mortgagors subject to foreclosure proceedings the right to continue to occupy foreclosed properties subject to the payment of fair market rent for a period of 20 years that begins upon the commencement of occupancy of such property.
The cost would be negligible, but it would freeze the foreclosure crisis in its tracks.
In sum, it’s encouraging that Obama is taking this plan to the people and that it will entail restructuring household mortgage debt. Its true test will be the plan’s ability to stop foreclosures if not encourage a reflation of the MBS market.
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