April 29, 2008
By Shiela C. Bair
Over the past year, federal and state governments, consumer groups, industry and others have worked to contain the growing tide of foreclosures. While some success has been achieved, foreclosures continue to mount and delinquency rates for subprime and even some prime mortgages have risen dramatically.
The US housing market needed to adjust after an unsustainable expansion. However, the lax lending of recent years has distorted this natural cycle. The existence of too many unaffordable mortgages has created a cycle of declining home prices and limited refinancing options that has contributed to more defaults, foreclosures and the ballooning of housing stock. This in turn has led to further home price declines. Government efforts should focus on helping the market reach equilibrium without overshooting.
This can be done only through widespread restructuring of unafford-able mortgages into affordable ones. However, it is questionable whether government programmes can, or should, help borrowers who view home ownership as a leveraged investment. Solutions should focus on those with a long-term commitment to remaining in their homes and paying their mortgages if they had an affordable payment.
The question is how to restructure unaffordable mortgages on a sufficient scale to stabilise home values and contain the broader economic damage. Solutions must be practical and administratively quick and simple to implement. We must also minimise any burden on taxpayers by keeping the risk of mortgage defaults in private hands.
Congress and the White House are moving forward with plans to expand eligibility for loans guaranteed by the Federal Housing Administration. These proposals are laudable and will help some borrowers, but they have generally acknowledged limitations.
As a complement, Congress may want to consider a publicly funded borrower loan programme. The Treasury department could, if authorised by Congress, make loans to borrowers with unaffordable mortgages to pay down as much as 20 per cent of their principal. Participating mortgage lenders would be required to restructure the mortgage to ensure an affordable, long-term payment and subordinate their lien interest - the right to retain possession of the property - to the government's claim. To give borrowers time to stabilise their finances and rebuild some equity, repayment of the Treasury loan would be delayed for five years and then amortised over the remaining life of the mortgage. Mortgage investors would pay a subscription fee to cover the government's interest costs during the first five years. To prevent gaming of the system, eligibility could be confined to loans originated in recent years that were unaffordable at origination, based on a simple debt-to-income ratio.
Borrower loan programmes have been suggested by eminent economists, such as Martin Feldstein. This proposal would require cost-sharing by mortgage investors as well as borrowers; it limits eligibility to mortgages that were al- ways unaffordable and provides a super- priority interest to assure repayment.
Importantly, this proposal keeps the risk of re-default on mortgage investors. It allows the government to leverage its lower borrowing costs to reduce fore-closures significantly with no expansion of contingent liabilities and little net cost. Ownership of the loans, with the corresponding risk of declining collateral values and credit risks, remains with the current mortgage investors. As a result, it has built-in incentives for mortgage investors to qualify those borrowers who have a good chance of paying off a restructured loan over the long term.
It also works within existing securitisation contracts and is administratively simple. In most cases, eligibility could be assessed with information readily available from existing records. Principal write-offs, which can require investor consent, are not required, limiting the prospect of potential conflicts of interest. Investors benefit by receiving immediate principal payments and from the reduced default risks.
Most importantly, those homeowners who remain committed to their homes would be given the means to ride out the crisis. For homeowners deeply underwater, turning to the FHA should be another option. The housing crisis is a national problem. Painful as it is, we must be prepared to apply government efforts now. The Federal Deposit Insurance Corporation's past experience cautions us that prompt action is always cheaper than a delayed response.
*The writer is chairman of the US Federal Deposit Insurance Corporation