Housing Crisis Basics

Federal Action Necessary to Prompt Private Sector Solutions to the Housing Crisis

March 10, 2008

A short history of how people used to buy homes ... and the slightly more complicated history of how we got into the housing mess we're in today:

The Problem

Federal action is urgently needed. The U.S. economy teeters on the edge of recession because of a vicious downward spiral in housing prices, escalating foreclosures, rising losses on mortgage-backed securities, contagion in more on their mortgages than their homes are worth. If prices fall another 15 percent, one-third of all mortgages would face negative equity.

• The number of properties entering foreclosure in the fourth quarter of 2007 set a record, with 7.9 percent of all loans now delinquent or in foreclosure.
• A housing market correction after unprecedented price appreciation is appropriate, and people should not be protected from unwise speculation, yet a panicked freefall not supported by economic fundamentals is bad for the economy.
• We are facing the prospects of a long, severe credit crisis and economic stagnation.
• Monetary and fiscal policy alone will not resolve the crisis.

As the housing bubble bursts, we see widespread recognition that the economy has offered little real progress for most in recent years Americans.

The market cannot resolve this crisis on its own. For almost a year the complex legal entities that hold these mortgages have failed to slow the pace of foreclosures—despite exhortations by the Bush administration for mortgage servicers, lenders, and investors to provide voluntary relief. Foreclosure action was taken on almost one million properties in the second half of 2007, with more in the fourth quarter of last year than in the previous quarter notwithstanding efforts by the voluntary HOPE NOW Alliance to curtail foreclosures. The result:

An inability to value underlying mortgage and other assets has been a major contributor to a worldwide credit market freeze.

If policymakers do not facilitate the restructuring of millions of at-risk mortgages in private hands quickly, on responsible and sustainable terms, then U.S. policymakers may soon face widespread international pleas for more dramatic steps, including direct government control of distressed mortgage assets.

The American economy is suffering. Concentrations of foreclosures lead rapidly to neighborhood decline and lost equity for surrounding homeowners—even those who are making timely payments on prime mortgage loans. The current credit crunch and a looming recession will mean economic pain throughout the U.S. economy. Specifically:

Lost equity spurs more defaults as borrowers under stress conclude that they cannot continue making mortgage payments with no prospect of retaining equity in their homes. And since housing equity and home mortgage debt have spurred economic growth, tightened credit and evaporating equity will continue to chill consumer demand, slowing the economy and resulting in job losses—just as inflationary pressures are appearing.

The unprecedented decline in house prices threatens the financial stability of states and localities. Foreclosed, vacant, and abandoned properties attract crime and vandalism,requiring municipalities to shift resources away from other local priorities. Heightened demand for government services comes as revenues, tied to property taxes, decline.

The Solutions

1. Saving America’s Family Equity Plan: Transfer, Triage, and Restructure At-Risk Mortgages Through Our SAFE Loan Program
 
The overarching goal of SAFE is to transfer large numbers of existing loans from the current holder of the mortgages—who is faced with a variety of uncertainties and conflicting interests—to new owners who will refinance them on affordable terms. The sale price paid would reflect the current value of those mortgages, significantly less than the face value. This “haircut” will ensure there is no bailout of the financial institutions and existing investors, many of whom uncritically and irresponsibly created the bubble by lending in the hope that continued house price appreciation would make up for the absence of meaningful credit evaluation. The resulting transfer will help to unfreeze financial markets. Current investors will exchange the mortgage-backed securities they hold whose value is uncertain for the liquidity and reduced market risk of Treasury securities or cash. Our SAFE program also includes complementary policies, such as:

Housing Counseling Resources. Counselors are essential partners in helping homeowners into restructuring programs, but the system must grow to meet the current and future needs.

New Federally Backed and Responsible Loan Products. Given market uncertainty, investors will only fund new SAFE loans if the government insures against catastrophic losses. Credit enhancements for new SAFE loans to owner-occupants would include more flexible Federal Housing Administration-insured loans as well as special programs for Fannie Mae and Freddie Mac.

A Mechanism to Prevent Borrowers from Getting a Windfall. Any loan that is written down to below current fair market value of the home could be accompanied by a “soft” second mortgage that permits the lender to recover an amount up to the difference between loan amount and current value, if the home is subsequently sold for more than the new loan amount. A shared-equity instrument would enable the owner, funder and insurer of the loans to share in home price appreciation up to the original loan balance.
 
2. The Great American Dream Neighborhood Stabilization Program
 
Our GARDNS Fund would provide state and local governments with up to $20 billion in new Community Development Block Grants or HOME funds for programs to return foreclosed properties to productive use. Funds would be targeted at communities most heavily impacted by foreclosures, and the funds would be used to purchase bank-owned properties at a discount which would be rehabilitated and then sold or rented affordably. Each community’s situation will dictate a different mix of strategies. Putting families into homes with payments they can sustain will not only provide a new source of affordable housing and prevent crime and blight; the GARDNS program will reduce housing inventories and keep surrounding house prices from falling further.
 
3. Judicial Loan Modifications
 
The House Judiciary Committee’s reported bill would conform the treatment of currently outstanding non-traditional and sub-prime mortgages on a primary residence to the treatment of other secured debt, including cars, second homes, and investment properties in Chapter 13 bankruptcy cases, in certain narrow circumstances. In addition to assisting borrowers in bankruptcy, the bill provides an incentive to servicers to speed up the process of voluntarily restructuring mortgages, where possible.

 

For more information about the Center for American Progress' policies on the housing crisis, see:

• Strengthening Our Economy: Foreclosure Prevention and Neighborhood Preservation
• Addressing Foreclosures: A Great American Dream Neighborhood Stabilization Plan
• A Practical and Progressive Economic Stimulus and Recovery Plan

To speak with our experts on this topic, please contact:

For TV, Sean Gibbons, Director of Media Strategy 202.682.1611 or sgibbons@americanprogress.org
For print or radio, John Neurohr, Press Assistant 202.481.8182 or jneurohr@americanprogress.org
For web, Erin Lindsay, Online Marketing Manager 202.741.6397 or elindsay@americanprogress.org
For radio, Andrea Purse, Deputy Director of Media Strategy 202.446.8429 or apurse@americanprogress.org