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At Last, Help for Homeowners

SOURCE: AP/Gerald Herbert

Housing and Urban Development Secretary Shaun Donovan, Treasury Secretary Timothy Geithner, and Federal Deposit Insurance Corporation Chair Sheila Bair talk prior to President Barack Obama's remarks today about the home mortgage crisis at Dobson High School in Mesa, Arizona.

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Interactive Map: Helping States Deal with Foreclosures

Report: A Great American Dream Neighborhood Stabilization Plan

Press call: Andrew Jakabovics on President Obama’s housing plan

In a sharp departure from the Bush administration’s largely hands off approach to the U.S. housing crisis as it metastasized over the last two years of his presidency, the Obama administration unveiled a comprehensive array of measures targeted at stopping foreclosures, allowing defaulted borrowers to stay in their homes, and helping neighborhoods recover. While there are ways in which such efforts could go still further to attack the estimated 10 million more defaults and foreclosures looming over the next few years, the plan contains many positive features.

Most importantly, President Barack Obama and his policymakers accept as a central premise that stopping foreclosures is good for all homeowners and the economy overall. This is long overdue and a welcome change in direction from the prior reigning conservative philosophy.

Over the past several years as foreclosures spread wildly out of control, dragging down the entire economy, Bush administration officials moved through various stages of failure—never taking appropriate action. First came denial. Despite mounting evidence in 2007 that foreclosures would set off a spiral of decline, Bush administration policymakers insisted that the problem was small and the economy largely immune from troubles affecting the subprime loan sector.

When the subprime crisis could no longer be denied—in the fall of 2007 into early 2008—Bush policymaking seemed based on a mix of blaming the victim and a belief that the market would self-correct. The Bush administration’s message was mainly that the culprits were unscrupulous borrowers who needed to be punished for their moral failures by withholding of any help. Thus, the antiforeclosure efforts that were launched were voluntary.

Despite inflated claims of success by participants in the Bush administration’s HOPE Now Alliance of lenders, few real loan modifications were accomplished, and over half of those that were modified failed to stop a later foreclosure. The reason: way more often than not these modifications in the end did not substantively reduce monthly payments or did little beyond offering a brief respite from crushing payments.

When international credit markets began crashing and foreclosures surged in 2008, causing record home price declines nationally, laissez-faire policies morphed into power grabs and bailouts for buddies. Give us a few more tools—a couple of “big bazookas” for former Treasury Secretary Henry Paulson, such as authorizing the government takeover of home mortgage giants Fannie Mae and Freddie Mac, or the purely voluntary loan refinance program ironically named HOPE for Homeowners, and finally $700 billion with no strings attached for a Troubled Asset Relief Program—and we will hold off the problems a little longer, the conservatives argued.

Several salient points are notable about this sorry saga beyond the near total failure to actually stop a previously unimaginable number of foreclosures. First, vastly more attention was paid to the woes of the banking system and credit markets than to the mounting hardships of millions of families stuck with bad loans. Under the Bush administration’s approaches, families were largely either the bad guys, or at most irrelevant to fixing the problem.

Even when Congress expressly mandated in its rewrite of the TARP legislation that buying up bad loans with the goal of giving homeowners breathing room to avoid further foreclosures was a key goal, Paulson and others bizarrely continued to claim they didn’t have the authority to do so.

Finally, essentially none of the available hundreds of billions of dollars worth of TARP funding went to stop foreclosures. Even after the chair of the Federal Deposit Insurance Corp., Sheila Bair, demonstrated the capacity of government to create and implement an effective system of foreclosure-preventing modifications, she was rebuffed by Paulson when she sought $25 billion from the U.S. Treasury. She too was told the cupboard was bare—at least for direct help to homeowners.

Now, for the first time, the federal government will be directly spending an estimated $75 billion of TARP funds on efforts to accelerate widespread loan modifications for the benefit of homeowners. Indeed, the Obama plan changes course on all three counts.

First, the plan clearly places foreclosure prevention at the forefront of the overall economic recovery battle. Foreclosure prevention is no longer regarded as a benefit that will somehow flow from pumping more funds into banks. Rather, recognition is plainly given to the basic fact that if over 10 million more families face the loss of their homes, then surrounding neighborhoods with 5 or 10 times that many families are all cutting back spending and shrinking the economy rapidly. The administration estimates that the average homeowner will be protected from $6,000 in price declines on their homes as a result of their plan.

Second, the plan wisely leverages Fannie Mae and Freddie Mac, whose losses are now effectively on the taxpayers’ tab, to refinance the mortgages they bought from originating banks to levels that will keep borrowers in their homes. In the past, Fannie and Freddie could only buy up mortgages written to 80 percent of the value of a property. In the current circumstances, when prices have fallen across the board, many people who are creditworthy and otherwise able to refinance cannot take advantage of low interest rates because of their lost equity. The new program allows Fannie and Freddie to refinance existing mortgages for borrowers whose loans are worth 105 percent of the property’s current value.

Importantly, this element of the Obama plan is expected to be nearly costless, as the losses from reduced interest payments are offset by not incurring high foreclosure costs.

The plan also provides clear guidance to mortgage service companies that delinquent borrowers and at-risk borrowers should be able to modify the terms of existing loans so that the monthly payment ultimately reaches 31 percent of income. For the first time, we see at-risk borrowers included in a widespread modification plan. This comes at a time when mortgage servicers still often tell responsible but distressed borrowers who reached out for assistance prior to falling behind on payments that the best way to get help was to stop paying the mortgage. The Obama plan eliminates that moral hazard.

The plan’s interest rate reduction comes in two stages, a reduction to 38 percent of income and then a step down to 31 percent. Mortgage lenders and investors in these mortgages (via their mortgage servicers) take the full loss of adjusting a loan’s interest rate down to the point at which the monthly payment is equal to 38 percent of income. To get down to the final 31 percent payment, half the difference between the payment at 38 percent and 31 percent will be paid for by the government.

This is where the bulk of the program’s costs come in. Servicers will receive an up-front incentive payment of $1,000 for making modifications in accordance with the program guidelines. Likewise, they will get $1,000 per year for three years, as long as the borrower remains current. In addition, the government will pay $1,000 annually toward the outstanding principal balance for up to five years if the borrower remains current.

The value of that principal payment will ultimately be far greater than just $5,000. Because interest accrues on the outstanding principal, keeping monthly payments fixed will mean that a larger share of the future mortgage payment will pay down principal. For example, on a $200,000 mortgage, these additional payments mean that a borrower will have paid down 10 percent of the balance in the fifth year of the loan rather than at the beginning of the seventh year. Paying down the borrower’s principal can help protect against borrowers choosing to walk away from their mortgages because it helps lower the chances they may find themselves underwater, owing more on their home than it’s worth in the marketplace.

One possible criticism of the plan is the incentive payments for servicers. At the end of the day, servicers still retain a fiduciary duty to their investors to maximize the value of the mortgages. If servicers determine that foreclosure will be more valuable than modifying a loan, their legal obligation is to foreclose. In nearly all cases, however, their fiduciary duty would tilt heavily in the direction of modification—given the costs of foreclosure, property maintenance, and tax obligations of acquired properties, and the inevitably steep losses that must be taken when trying to subsequently sell the home.

With strong guidance from a range of government entities indicating that modification along these guidelines is to be accepted as standard industry practice, substantive loan modifications should become widespread, even absent incentive fees. Servicers should receive some level of payment to recover the costs of modifications and perhaps some small additional payment as incentive to modify according to these guidelines rather than simply offering repayment plans that are unlikely to prevent foreclosures, but $4,000 in total incentives seems unnecessarily high.

Crucially, though, recipients of TARP funds moving forward will be obligated to participate in mortgage modifications along the guidelines set out in this program. While this aspect of the program is buried deep in the details, it may have the most force of all. The top four mortgage servicers as of the end of 2008 were responsible for over $6 trillion in outstanding mortgages. Their names? Bank of America, Wells Fargo, JP Morgan Chase & Co., and CitiMortgage (the mortgage servicing arm of Citigroup Inc).

Finally, by endorsing a bankruptcy change benefiting homeowners who owe more than their house is worth, they are signaling that lenders will no longer be able to simply try to wait out the problem or march forward with a foreclosure. This last piece of the Obama plan will require new legislation, and we urge Congress to act quickly.

Over the past 18 months, the Center for American Progress has advocated for approaches embodying these principles. We continue to believe, along with a growing number of respected economists, that without bringing foreclosures to a halt in as many cases as possible, economic recovery will be virtually impossible. To this end, still more tools are available to the Obama administration as it rolls out its full plan, including modifying so-called REMIC rules governing the trusts that hold the mortgages to eliminate artificial barriers to modifications.

We urge the new administration and Congress to examine these recommendations.

More information from CAP on housing:

Interactive Map: Helping States Deal with Foreclosures

Report: A Great American Dream Neighborhood Stabilization Plan

Press call: Andrew Jakabovics on President Obama’s housing plan

Complete list of housing materials

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