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Bailout Fantasies

SOURCE: istockphoto

Neighborhood stabilization will help those neighborhoods most affected by large numbers of foreclosures and will indirectly help struggling borrowers by reducing the number of unsold homes on the market.

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The Bush administration, through a letter sent by the Department of Housing and Urban Development, strongly hinted at a possible veto of neighborhood stabilization legislation now before Congress. The Neighborhood Stabilization Act of 2008 would provide funds for the purchase and rehabilitation of foreclosed properties to restore them to productive use as affordable housing.

The administration is expected to claim that the bill would provide a bailout to lenders, encourage lenders to proceed to foreclosure faster, and be slow to work. The first two claims are specious at best, and the third contradicts the first two claims. Bush administration financial policymakers knee-deep in a housing and credit crisis of their own making must know this to be the case, but it is worth spelling out given how important this legislation is to neighborhoods devastated by the subprime mortgage crisis.

Let’s start with the first false claim—that the funds will be a bailout to the lenders. The neighborhood stabilization funds contained in the Neighborhood Stabilization Act will be used to buy properties owned by banks, which superficially means that in the course of the transaction federal funds will be transferred to banks. But simply engaging in a transaction with a bank does not inherently a bailout make, especially when the federal funds are deployed by local governments and neighborhood non-profit groups that want to help stabilize their communities.

Banks holding foreclosed properties are looking to dispose of them, and will sell to interested parties at a certain price. They are largely agnostic as to who sits opposite them at the table. They are likely to be as happy selling to a non-profit group that will provide a social benefit—by rehabilitating the property for sale or rent to a family that can afford it—as they would be selling to a speculator looking to flip the property for a quick buck after slapping a coat of paint on it.

Indeed, given the volume of bank-owned properties in communities suffering the most from the foreclosure crisis, the banks are likely to prefer a bulk sale to a non-profit group over a property-by-property disposition to speculators. This in turn means that nonprofits would negotiate from a position of strength, giving them an opportunity to purchase distressed assets at a steep discount. In communities deeply hit by foreclosures, bank-owned properties often sell for less than $10,000. That’s hardly the recipe for a bailout.

Moreover, non-profit groups know the costs they are likely to incur to rehabilitate the properties, and anyway operate in a culture where every dollar counts. They will most certainly drive very hard bargains. Thus, the administration’s claim of a bailout demonstrates an utter lack of understanding of bank behaviors and motivations as well as the impact that speculators can have on communities.

If anything, failure to provide funds for neighborhood stabilization will open the door for unwarranted windfall profits for speculators. Surely that is not the motivation for the threatened veto?

The second false claim—that the program will encourage banks to foreclose faster—rests on the false assumptions that banks are now modifying mortgage terms for struggling homeowners still in their properties, and that banks would speed up the process if given the chance to foreclose and flip their mortgages to non-profit groups. The sad truth is that the abysmal failure of the administration’s voluntary Hope Now alliance of lenders, investors, and mortgage servicers to prevent foreclosures across the country means that servicers continue to foreclose on twice as many properties as mortgages they choose to modify.

Neighborhood stabilization funds will help those communities most affected by these rolling foreclosures, but they would have no effect whatsoever on banks’ decisions to foreclose on properties. Foreclosures proceed according to the logic of legal contracts and mortgage service fees, which Hope Now Alliance members have demonstrated they adhere to far more stringently than to notions of voluntary debt renegotiations with individual distressed homeowners

In fact, absent bulk refinancing of outstanding at-risk mortgages into sustainable loans—a separate proposed solution to the housing crisis to help millions of homeowners at risk of losing their homes—foreclosures will continue to swamp local housing markets and prevent their normal functioning. But given the discounted price likely to be offered for any bank-owned property under a neighborhood stabilization program, and the costs incurred in proceeding to foreclose on a property, there is little incentive for banks to rush foreclosures simply on the off chance that a given property might be able to be sold to a nonprofit at a steep discount.

The Bush administration’s final claim that neighborhood stabilization funds will be deployed too slowly to help struggling homeowners contradicts their first two claims. After all, any program that slowly disburses funds that at some point will end up in banks’ hands as the result of a purchase of foreclosed properties hardly amounts to a bailout, as the banks need the money now. But the claim is also irrelevant. Neighborhood stabilization is not designed to directly help struggling homeowners; the companion bill to offer Federal Housing Administration refinancing on loans written down to market value helps struggling homeowners directly. We have consistently argued that neighborhood stabilization efforts like our GARDNS proposal must be paired with the bulk transfers of existing mortgages that allow refinancing of loans on sustainable terms, but in and of itself, neighborhood stabilization has never been intended to directly aid struggling homeowners.

Indirectly, however, neighborhood stabilization will help struggling borrowers by reducing the supply of unsold homes on the market, which can potentially make selling the property a viable option for those who cannot refinance an unsustainable loan. The program will also ensure that thousands of shuttered properties do not remain vacant over the next several years, which will also boost the value of homes in these neighborhoods.

The threatened veto of congressional housing legislation that includes neighborhood stabilization funds is wrong on its merits and wrong on its morality. The president and his advisors should think again about the pending decision. And the threat of a veto should not be used by congressional leaders to deny citizens’ duly elected representatives the opportunity to try to provide needed funds to help their constituents.

Andrew Jakabovics is the Director of the Economic Mobility Program at the Center for American Progress. For more information on our housing proposals please go to our Housing page on our website.

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