One in seven. That is the astounding proportion of American families in default on their home mortgages. And if we don’t take bolder steps soon to get ahead of this ongoing foreclosure epidemic, it could easily evolve into a self-perpetuating malaise destroying decades of home ownership progress.
Despite some stimulus-induced uptick in home buying recently, house prices have continued to drop in 2009. Roughly 14 million primary borrowers—roughly 27 percent—now owe more than their homes are worth. And that proportion is expected to soar to nearly one-half of all homeowners with mortgages “underwater” by 2011.
Fear of foreclosure permeates the life of middle-class families far more pervasively than just a few years ago when the situation could still be labeled a “subprime” crisis. Today, it is a side effect of unemployment, with 8 million or more foreclosures expected over the next few years.
However well designed and well intentioned, the Obama administration Making Home Affordable program has simply not overcome the tendency of mortgage servicers and banks to do the bare minimum modifications required under the current rules in force.
It has for some time been apparent that the current foreclosure crisis is the economic equivalent of H1N1. Multiple foreclosures in many communities are infecting neighboring homes with rapid value destruction. All neighbors are at risk if someone loses income due to unemployment or a cut back in work hours.
Even homeowners who avoid default find themselves “upside down,” owing more on their home than the market says it is worth. They lack home equity to fall back on for unexpected setbacks, college tuitions, and health care emergencies.
Families with no equity cut back on spending, further contracting the economy. As the infection spreads unchecked, we see further lost tax revenues, increased crime, more costly fire prevention, and a general draining of public resources.
So it is time to change the rules or face even more dire economic consequences.
What more can be done? More scattershot home buying credits will not change the dynamic, nor will variations on an essentially voluntary approach for mortgage modifications.
To paraphrase Sherlock Holmes: When you have eliminated all the convenient and politically possible solutions, whatever remains, however improbable, must be the truth. Several concrete solutions are possible to change the dynamic driving mounting foreclosures:
A growing number of policymakers now recognize the need for a mandatory mediation process such as one outlined last June by the Center for American Progress’s Andrew Jakabovics. Some state and local jurisdictions have already required mandatory mediation between borrower and lender as a step before a foreclosure can proceed, recognizing that “more than 80 percent of homeowners at risk of losing their homes had not engaged in any efforts to mitigate foreclosures with their lenders or servicers as of the end of last year.” Results show that this process reduces the housing crisis’ impact on neighborhoods; unclogs courts; and achieves faster, cheaper, and better resolutions for homeowners, mortgage lenders and servicers, and the community at large.
Congress could adopt a national mandatory mediation requirement as an essential filter between preventable foreclosure and those for which no reasonable alternative exists.
The Center for American Progress and others have previously put forward a proposal to modify the Real Estate Mortgage Investment Conduit, or REMIC rules, to accelerate modifications and prevent unnecessary foreclosures. And even more drastic changes are warranted as the situation has worsened.
REMIC status bestows enormous tax benefits to investors who funded the mortgage trusts that hold millions of home mortgages. The point of the tax break, however, was to encourage private capital to flow responsibly to encourage a public good.
But the REMIC format has turned into a straightjacket with millions of these same mortgages now marching toward foreclosure. Recognizing that REMIC status is a special privilege, it is time to revoke REMIC status for any residential home mortgage loan holding entity that forecloses on more than a specified percentage of all of its mortgages.
It takes such an extreme shift in the incentives to move mortgage service companies that collect individual mortgage payments and distribute them to their investors to modify troubled home mortgage loans or sell them off at a discount. Faced with revocation of REMIC status, servicers would finally be compelled to halt foreclosures and restructure loans to affordable levels—or sell them to those willing to do so.
Congress already authorized the Treasury Department through its Troubled Assets Relief Program to buy up troubled mortgages, and previously funded the Federal Housing Administration as a source of refinancing. Yet this substitution of affordable loans for unaffordable albatrosses around the necks of consumers seems to be happening only surreptitiously in places where investors can profit from bank failures. We need to convert all servicers to sellers, or at least into parties willing to face the drop in home value and find a long-term solution that works for the homeowner.
National foreclosure moratorium
State after state adopted moratoria on foreclosures in the 1930s. The U.S. Supreme Court upheld this dramatic action as warranted to stem the downward economic spiral affecting broad public interests. This time, with the detriment to the national economy far more apparent, a federal moratorium is justified both to stop further price declines and to make more aggressive loan modifications a better alternative for lenders than waiting.
Congress could begin with a six-month moratorium to create a reasonable time for the various other proposals and modifications programs to work. If enacted with the exploding REMIC changes, a moratorium could create an orderly period for mortgage transfers to occur. Any moratorium should, however, be easily extendable, perhaps by presidential order, as the situation will remain fluid for some time.
Even the bankruptcy playing field
Single-family homeowners should finally get the same rights in bankruptcy proceedings as commercial real estate owners, and even second-home owners. Congress earlier this year considered granting judges the authority to force a lender to restructure a homeowner’s mortgage on a primary residence to a level that reflects the current home value. Not only would this be fairer—since the unanticipated loss in home values is far beyond what either party could have anticipated, yet currently falls only on the consumer—it would also change the negotiation balance in a way to accelerate real modifications.
But Congress caved in to the lending industry’s arguments, hoping this situation would correct itself. It hasn’t. Now we need to give homeowners the same bankruptcy options as Donald Trump enjoys, if only to avoid the far worse consequences of millions more foreclosures stretching on for years.
Inaction at this point will just perpetuate what may in the end be a major market failure. We continue to see a frozen, malfunctioning market because it is almost impossible for the marketplace to work itself out in any reasonable way with mortgage-backed securities’ financial complexity and split ownership, combined with a market where buyers are sitting on the sidelines while prices plunge.
Only a market fundamentalist could at this point maintain that government action to unclog the logjam is worse than the current situation. At worst, some of the above solutions may be declared “takings”—but our legal system has well-established mechanisms for looking back and valuing property after it is taken.
The solutions on the table for the past two years have lagged behind the problem. It is time to get ahead of the foreclosure crisis before one in seven becomes one in five.