The Next Bailout: Helping Homeowners in Distress

TIME
By Massimo Calabresi

A week into difficult talks, agencies within the Bush administration are struggling to agree on a far-reaching new plan that would rescue homeowners with mortgage woes and ease the vicious foreclosure cycle that plagues the housing market.

Participants in the talks, including officials from the Treasury Department, the Federal Deposit Insurance Corp., the Department of Housing and Urban Development and other agencies, are focusing on two possible plans, say sources familiar with the discussions.

The first plan, backed by FDIC chairwoman Sheila Bair, would create an incentive for banks to change the terms of troubled mortgages by guaranteeing mortgages for millions of Americans who are struggling with their house payments but are otherwise creditworthy. The plan would use up to $50 billion of the $700 billion in bailout funding approved recently by Congress and would draw on new loan guarantee authority passed under the bill. The federal government would guarantee loans readjusted for homeowners who can show annual income worth 38% of the debt on their house. Under the plan, lenders would be encouraged to lengthen the loan terms and make other adjustments in order to lower monthly payments to help borrowers keep their homes.

Those principles are similar to the ones the FDIC worked out for the 60,000-odd bad home loans it took on when it closed IndyMac, a failed California bank, last summer. Bair outlined her proposal in Oct. 23 testimony before the Senate Banking committee. "The government could establish standards for loan modifications and provide guarantees for loans meeting those standards," she said. "By doing so, unaffordable loans could be converted into loans that are sustainable over the long term." At the same hearing, Neel Kashkari, the acting Assistant Treasury Secretary in charge of the $700 billion bailout package, said his department is "passionate about doing something about foreclosures and encouraging loan modifications."

A second plan being discussed calls for the expansion of existing housing assistance programs run by the Department of Housing and Urban Development, according to an Administration official. The official said there were advantages to using existing HUD programs rather than starting a new one from scratch, adding that it was unclear who would administer the FDIC's plan. "There's a lot of work to do to flesh out [Bair's] idea," the official said. Congress and both candidates for President have also discussed potential homeowner bailout programs of their own.

By rescuing struggling homeowners, the Bush administration hopes to avoid further damage to neighborhoods and the economy caused by cascading foreclosures. By creating a safety net for the housing market, officials also are aiming to reduce the uncertainty surrounding the soundness of the country's mortgage debt. A rapid and nearly unprecedented rise in bad home loans that began in 2007 triggered the credit crisis and has caused the failure of hundreds of banks and other lenders.

Not all struggling homeowners will be covered in a bailout, another Administration official stressed. The plan is to assist only people with sustainable home loans, not borrowers who made bad decisions and are stuck with mortgages they clearly can't pay off. "We're not doing anything for people who are under water," said the official. The FDIC plan would attempt to filter out "the people we can't help. There are foreclosures that will go forward." The process of sorting good from bad loans would also provide clarity for mortgage markets by helping financial institutions assess where the risks are in their loan portfolios and by making it easier to determine the value of mortgage-backed securities.

It was originally hoped a deal could be reached by Oct. 31, but that now appears in doubt, sources said. While they have publicly shown a united front, Bair has locked horns repeatedly with officials at Treasury and the Federal Reserve during the scramble to deal with the financial crisis over the past year. In previous talks to expand the responsibilities of the FDIC, critics accused Bair of being more concerned with protecting her agency than halting panic in the system. Bair responded by saying FDIC insurance for everyday Americans was too important to put at risk without sufficient guarantees of its stability.

In these talks, however, it appears that the breadth of her proposal is causing friction. HUD's existing programs would seem to be the natural foundation for a mortgage rescue plan. But part of the problem in addressing the housing crisis is figuring out which loans can still be serviced, since some banks required little or no documentation of a homeowner's ability to carry the loans. The FDIC's role as a bank overseer is viewed as giving it more insight into the quality of loans on banks' books.

A final hitch may be the perennial problem of who gets credit for the plan once it is agreed on. Several sources stressed that the deal's rollout, whenever it occurs, would come from the White House, not the agencies who were negotiating the details.