As the desperate efforts to ease the economic crisis bounce from one bailout to the next, the stabilization of the housing market remains a critical missing piece. Beyond appealing to the private sector to voluntarily modify loans, Treasury Secretary Henry Paulson has offered little to directly help distressed homeowners while raining billions on faltering financial institutions such as Citigroup, which received an injection of cash and loan guarantees over the weekend.
The private sector has not been willing to take the strong medicine required to effectively deal with the housing collapse. Only slightly more than 4 percent of loans in serious default are modified each month; even then the terms are often too harsh to allow homeowners any real chance of keeping their houses. Government has a financial and moral responsibility to do more for homeowners who are struggling to hang on to their most important investment.
One of the first steps should be for Congress to allow the modification of primary residential mortgages in bankruptcy court. There is no compelling reason why these are the only kinds of loans that bankruptcy judges are barred from altering. Mortgages on vacation homes can be modified, as can homes bought for investments. It is only residential mortgages that have been put beyond the court's reach.
There also is a promising plan offered by the chairwoman of the Federal Deposit Insurance Corp. that could standardize home loan modifications for all borrowers. Sheila Bair has broken with the Bush administration to strike a reasonable balance between revising terms of oppressive mortgages and avoiding an invitation to intentional defaults.
The point is to keep people in their homes to steady the housing market, reduce the personal disruption that foreclosure brings American families and protect the integrity of neighborhoods and communities. Bair's plan would keep an estimated 1.5-million people from foreclosure.
Borrowers who are behind at least two months would be able to seek a modification of their monthly payment, and the new payment could be no more than 31 percent of the borrower's income. That could be accomplished by lowering the mortgage interest rate to as low as 3 percent. Or the mortgage could be extended from 30 years to up to 40 years and payments on the principal could be deferred. The borrower would be responsible for the full value of the loan.
In exchange, mortgage holders would be given a government guarantee so if the borrower defaults, the government would in most cases pick up half the loss. That guarantee would be good for eight years, but it would only begin after the homeowner made six of the new payments.
Bair put a similar plan in place after the FDIC seized IndyMac. The FDIC has modified thousands of IndyMac home loans largely by reducing the interest rate, and the early results are promising.
Opponents say that Bair's plan would encourage irresponsible borrowers with high-interest mortgages to default even if they could keep paying, and it would mean the private sector would transfer some of its foreclosure exposure to the government. But this economic crisis has been fueled in large part by people defaulting on mortgages they cannot afford. Bair estimates it would cost $24-billion to sharply blunt the cycle of foreclosures feeding housing price declines. These days that kind of money seems like a bargain. And Bair says if her plan kept home prices from falling an additional 3 percent, that would translate into $500-billion in homeowners' equity saved.
Allowing bankruptcy courts to modify mortgages of primary residences and considering some version of Bair's proposal would direct more help to homeowners and prevent the further deterioration of neighborhoods with a growing number of empty houses in foreclosure. These actions would be an investment in the broader economy, and Congress should give them serious consideration.