Crisis Averted but Unresolved
SOURCE: AP/Susan Walsh
Actions taken over this weekend by Treasury Secretary Henry Paulson to place home mortgage giants Fannie Mae and Freddie Mac in conservatorship staved off a liquidity crisis by keeping money flowing for home mortgages, but we must be absolutely clear that those actions do not address the existing housing crisis directly. Conservatorship, however, does create an opportunity for the Treasury department and the Federal Housing Finance Agency, or FHFA, to stabilize local housing markets through wholesale restructuring of loans it now holds or controls at the two government-sponsored entities, or GSEs.
The current housing crisis was precipitated by an excess of home loans issued using shoddy underwriting standards and difficult loan terms. By restructuring or refinancing those loans already delinquent or in default—alongside those likely to soon follow—into loans that the borrower can sustain, local housing markets will no longer be threatened by a flood of foreclosures and will be able to return to normal functioning. Given that the taxpayer is potentially on the hook for the GSE debt, maximizing the returns on the outstanding loans is in our collective best interest.
American taxpayers will do better when the FHFA-appointed conservators refinance or restructure the outstanding troubled mortgages in the two GSEs’ portfolios to provide lower interest rates or loan balances, rather than having the GSEs sit on a pile of delinquent, non-performing loans leading to foreclosures next door. That’s why the FHFA should follow the lead of the Federal Deposit Insurance Corp in its role as receiver for the failed IndyMac Bank.
Several weeks ago, FDIC chairwoman Sheila Bair announced that the FDIC, acting in its role as receiver for IndyMac, would begin a streamlined process for making substantive changes to loans under its control. Bair has long been an advocate for widescale restructuring of outstanding troubled loans rather than proceeding to foreclosure, arguing that doing so benefits lenders and investors in addition to keeping families in their homes.
The FDIC will make modifications not only to mortgages owned by IndyMac outright, but also to securitized loans for which IndyMac served as the servicer. In modifying loans held in the servicing portfolio using a streamlined process, the FDIC issued a direct challenge to the servicing industry, which has long argued that it could only make changes to loans one at a time and has generally been very hesitant to make any changes to loan terms.
The Center for American Progress argues that the streamlined process the FDIC is using should be applied to the mortgages held by the GSEs in their own portfolio and in the mortgage-backed securities they hold on their books. This could be implemented relatively easily through the GSEs’ existing underwriting software platforms. If the actions taken by the FDIC are considered too small to establish a standard industry practice upon which other servicers could rely for making loan modifications within their existing contracts, the use of streamlined modifications by the GSEs, which held 42 percent of the country’s outstanding residential mortgage debt at the end of the first quarter, would unquestionably establish the necessary legal standards.
Moving beyond FDIC-type modifications, the Treasury and FHFA should also seriously consider implementing a bulk refinancing and transfer program similar to CAP’s SAFE loan program. The SAFE loan program would take existing mortgages held in portfolios or that have already been securitized and refinance them on sustainable terms based on the current value of the property. The new, sustainable mortgages would then be resecuritized and sold, effectively reducing risk in outstanding mortgage pools. Under the terms of the conservatorship, the GSEs will need to reduce the size of their retained portfolios to less than $250 billion. This provides an opportunity for Treasury to refinance the loans they now hold into sustainable mortgages and package them for sale to third parties.
The housing crisis will see relief when mortgages and homes become affordable. The GSE conservatorship provides that opportunity, but the Treasury’s actions this weekend do not directly address that issue. The conservators must act decisively to set a standard for wholesale loan modification and, in doing so, reclaim government’s historical role of leading by example.
Andrew Jakabovics is Associate Director of the Economic Mobility Program at the Center for American Progress. To read more about the Center’s housing policies and analysis, please go to the housing page on our website.
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