By Andrew Jakabovics
It was high time for President Bush to pay attention to the mortgage market and recognize the spreading pain felt by struggling American homeowners. The president firmly (and correctly) asserted today that it isn’t the government’s job to bail out speculators, but in a possible philosophical sea change, he also acknowledged that government has a role to play in the growing home loan crisis. Unfortunately, he said its role was limited largely to asking lenders to be nice.
In my opinion, we have two alternatives to solving the threat of widespread delinquency and foreclosure. We can push a wide stream of water through an increasingly leaky pipe trying to get a narrow trickle-down to the homeowner at the far end, or we can simply walk up to the homeowner and offer her a drink of water. We need to assist troubled homeowners, not bail out lenders or investors who neglected their due diligence.
The president needs to realize that it is the Mr. Potters of the financial world, not the George Baileys, who are running the banks. President Bush encouraged lenders to negotiate less onerous lending terms with their borrowers and proposed a tax code change so that cash-strapped borrowers could avoid inadvertent tax hits if their lenders voluntarily agreed to some degree of loan forbearance. But the president’s plan assumes that lenders will be willing to talk to their borrowers about lender forbearance under renegotiated terms that could lead to a tax on the amount of the write-down.
Alas, the mortgage market has evolved to be far more complex than “It’s a Wonderful Life.” An individual borrower no longer goes to the local bank to get a loan using money from depositors and relying on the banker’s personal knowledge of the borrower. Today, mortgages are rarely held by the banks or other lenders that issued them initially. Instead, the mortgages are given a rating and pooled with other similar loans for sale to Wall Street.
The price for the pool of home loans is based on its size as well as the risks associated with it. Investors then buy shares in the pool, and their returns come from each month’s mortgage payments. An entire servicing industry has emerged to process these payments from borrower to investor. In most cases, the servicer is the only point of contact for the borrower.
This presents a serious challenge when homeowners are told to contact their lenders when they are in danger of falling behind on their payments. In case after case, we have seen borrowers reaching out to their loan servicers asking for assistance only to be told the servicers’ hands are tied. The servicers merely accept monthly payments from the homeowners and pass them along to the hedge funds and other entities that bought the loan bundles.
In fact, servicers have contractual obligations that limit their ability to negotiate terms. Simply asking lenders to be nice is simply not a realistic solution in many cases.
Similarly, Bush’s call for modernizing the Federal Housing Administration is well-intentioned but unlikely to solve the current crisis. The president wants to enact a bill that passed the outgoing House of Representatives last year that would give the FHA more ability to price their insurance based on risk and raise the loan limits. This bill was ignored by the then-Republican Senate. A similar, but stronger, bill with more borrower safeguards has since been introduced by Democrats in the new Congress This bill will also include a directive to assist high-risk borrowers and use program surpluses to fund affordable rental housing and affordable homeownership.
Over the long term, FHA modernization, along with shoring up our lending infrastructure by preventing predatory lending, expanding counseling for first-time buyers and at-risk owners, and establishing fiduciary duties for mortgage brokers, among other changes, will continue to make safe credit available for families seeking to become homeowners and will offer greater transparency throughout the system. These types of reforms would help everyone, from first-time home buyers to faraway investors in mortgage-backed securities.
Our nation’s short-term response, however, must be directed at the homeowner in trouble. We need to reestablish the Home Owners’ Loan Corporation. During the New Deal, HOLC was a short-term entity authorized to issue loans directly to homeowners in default. Its direct loans allowed homeowners to refinance into fixed-rate, fully-amortized, long-term loans and paid the lenders fully insured, tax-free bonds in lieu of the existing loan.
The efficacy of HOLC came from its directness and its ability to meet the needs of the homeowners and the lenders. In a HOLC-style loan program, investors holding home loans would need to agree to accept a reduced return on their investments—action that only an agency such as the HOLC would be able to negotiate on a mass scale because it would bring considerable powers of persuasion to induce the loan holders to the bargaining table.
During the Depression, banks initially balked at accepting HOLC offers, but they ultimately changed their minds, recognizing that the 4 percent guaranteed bonds they were offered handily beat the 0 percent returns on unpaid mortgages. Investors in mortgage-backed securities are increasingly facing a similar choice today; we have only begun to see the first wave of foreclosures and delinquencies.
The United States has a long history of providing help to homeowners at risk. By directly assisting homeowners who are about to lose their homes, we as a nation have an opportunity to protect the gains in homeownership rates we have seen over the past decade, prevent the widespread erosion of home equity, and stabilize neighborhoods.
Just as the HOLC paved the way for the FHA to provide safe mortgages during the Depression, today a similar agency could ensure that FHA modernization focuses on a longer term need for a positive role for government in housing finance. Our short-term needs, however, require direct assistance. The HOLC is a proven model for success.
Andrew Jakabovics is Associate Director of the Center’s Economic Mobility Program.