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6 steps to fix the housing market

Officials, activists agree any new stimulus package should do more to mend the mess in real estate

Representative Barney Frank (left) and Senator John McCain argue the government should buy up troubled loans instead of waiting for lenders to figure out how to fix them. (Left: Pat Greenhouse/Globe Staff; Right: David Martin/Getty Images) Representative Barney Frank (left) and Senator John McCain argue the government should buy up troubled loans instead of waiting for lenders to figure out how to fix them.
By Jenifer B. McKim
Globe Staff / November 16, 2008
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The housing market is beginning to resemble one of those super bugs that are resistant to modern medicine: Despite injections of help from the government and lenders, it's still sick. Foreclosures continue at an alarming pace, sales are few, and mortgages are hard to come by.

Just this week Treasury Secretary Henry Paulson said he would not use taxpayer funds to buy up troubled mortgage-related securities, as was originally intended by the passage of the $700 billion federal bailout bill. Congress is expected to develop a new economic stimulus package in the coming weeks, and many housing industry officials and activists hope lawmakers will use the opportunity to devote more attention to fixing the nation's real estate problem.

Here are six of the top ideas being mulled in Washington, and among industry specialists.

1. Cut the rates
How does a 2.99 percent mortgage sound? Silly? Maybe 5.25 percent? Discount loan rates could draw home shoppers off the sidelines and into the market, boosting sales and helping to check falling housing prices. One proposal, plugged by Columbia Business School dean R. Glenn Hubbard and Columbia Business School professor Chris Mayer, includes refinancing primary residences into 30-year fixed-rate mortgages at 5.25 percent placed under mortgage giants Fannie Mae and Freddie Mac.

The National Association of Homebuilders, with 235,000 members, wants Congress to include in the upcoming economic stimulus package a subsidy on conforming 30-year loans that would lower the interest rate to a bargain 2.99 percent. The rate would be for all mortgages on homes purchased through June 30, 2009. For homes bought in the second half of 2009 the subsidized interest rate would be 3.99 percent.

2. Make like Sheila
Sheila is Sheila Bair, chairwoman of the Federal Deposit Insurance Corp., who's become something of a cult hero among housing activists because of what she's doing for customers of failed IndyMac Bank who are facing foreclosure. Her agency is systematically modifying these mortgages to more affordable levels, so borrowers' monthly payments are as low as 31 percent of their income. Already around 5,000 customers have had loans adjusted by an average of $380 a month or about 23 percent. Methods include lowering a loan's interest rate, forgiving some of the principal debt, or extending the repayment period. Importantly, Bair would pay loan servicers $1,000 for every mortgage they modified, giving them an incentive to work out, instead of foreclose on the loan.

Bair wants to expand the IndyMac model across the industry. One problem: Too many of the borrowers who receive help still have trouble affording their homes and end up being foreclosed on again. The FDIC proposes that the US government would absorb up to half of the losses of those homeowners who default a second time, with the lenders or mortgage holders eating the other half. The estimated cost is $25 billion. The rub? Paulson has frowned on spending that kind of money because taxpayers are unlikely to recoup these losses.

3. Own the loan
Senator John McCain, US Representative Barney Frank, a Newton Democrat, and various academics have come up with a simple idea: Have the government buy up troubled loans instead of waiting for lenders to figure out how to fix them. This, they argue, would speed the pace of loan modifications, more quickly helping distressed homeowners avoid foreclosure. One novel approach involves using the government's power of eminent domain to take, not the property, but the loan notes from investors who may be reluctant to part with them.

During the presidential campaign, McCain suggested using around $300 billion of the bailout fund to buy hundreds of thousands of loans. The government would then issue those homeowners new loans at more affordable levels. Other supporters have suggested the original lenders would have to forgive a portion of the old loan, if the home has since lost value, as part of the buyout agreement. But now that Paulson has nixed the idea of spending bailout funds on mortgages, it's unclear where funds for a loan buy-up would come from.

4. Share the pain, gain
A growing number of proposals resurrect an idea known as "shared appreciation mortgages," in which struggling homeowners would be forgiven a portion of their mortgage debt. In exchange, if the home appreciates in value or the borrower later sells at a profit, the lender would get a share of that profit.

The arrangement is a component of the federal Hope for Homeowners program, a new loan program at the Federal Housing Administration that refinances mortgages for homeowners who owe more than what their house is currently worth.

Academics such as Andrew Caplin and Thomas Cooley of New York University argue that the agreement gives taxpayers an "ownership stake in the future." The shared appreciation model was used years ago in limited measure, but has largely stalled because of an arcane tax ruling by the Internal Revenue Service.

Meanwhile, Hope for Homeowners got off to a slow start, partly because lenders are required to write down loans to participate. It now has 180 lenders enrolled, although some will only finance loans in certain areas of the country.

5. Buy cooperation
Harvard Law School professor Elizabeth Warren is circulating a proposal to buy cooperation from mortgage servicers, who perversely are in the position of making money doing a foreclosure. Many loan servicers, who are the liaisons between homeowners and investors, are limited in what they can change in loans by contract terms with the loan holders.

Warren said even if legal issues are eliminated, servicers need financial incentives to help homeowners. She proposes the US government pay servicers for each loan modification that results in a family receiving a fixed-rate mortgage with an affordable payment. Secondly, she said owners of second mortgages, who often block modifications because they stand to lose money, should receive a 10 percent bounty on the face value of the loan for writing it off and getting out of the way. Finally, she recommends a fee for specialists who assist homeowners through the negotiations and paperwork. The mortgage problems are too complex to be solved without the help of some highly incentivized middlemen, she argues.

6. Reform bankruptcy laws
This is another idea that has been around the track before and remains popular. Some Democratic lawmakers and housing officials want to amend bankruptcy laws so judges would be allowed to modify a debtor's mortgage as part of a bankruptcy proceeding. The plan was excluded from the original bailout plan but proponents want to re-insert it in the new stimulus. Nobody wants to go into bankruptcy, but when losing your home is the other option, advocates of the law change say this could make a world of a difference. Some hope the law change would push lenders to work harder to modify loans before going to court. Opponents, however, counter that this authority would violate the sanctity of contracts and be a remarkable intrusion into private business matters.

Jenifer McKim can be reached at McKim@globe.com.

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