Solve mortgage mess at its source, experts say

InvestmentNews, NY
By Janet Morrissey

Many think that federal money should be channeled to strapped homeowners

A growing number of economists and industry experts are baffled that Treasury Secretary Henry Paulson didn't earmark a portion of the $700 billion bailout package directly for homeowners facing foreclosure when he revamped his plans for the cash last week.

"If we don't do something about housing, nothing else we do is going to matter," said Chris Mayer, senior vice dean of the Columbia University Business School in New York. "We could give $50 billion to General Motors [Corp. of Detroit], but it's not going to stop the markets from continuing to spiral downwards."

Saying that buying up mortgage assets "is not the most effective way" to use government funding, Mr. Paulson last week scrapped his original plan to buy up troubled mortgage-related securities from financial institutions.

Instead, he now plans to make direct cash injections into different companies such as credit card firms, companies that make auto and student loans and other non-bank financial institutions. But Mr. Paulson made no mention of directly helping the millions of Americans now facing the threat of foreclosure.

The tidal wave of foreclosures and the deepening housing crisis likely won't subside until the federal government passes legislation offering big incentives — or possibly making it mandatory — for lenders to renegotiate loans with homeowners, experts said.

Most experts commend the government for making cash injections into the country's major banks to stabilize the banking system. However, they vehemently object to extending the program to insurance companies, automakers and others who have bellied up to the bar looking for a similar handout.

Instead, they think that cash must be pumped into a program that stops foreclosures directly at the source — the homeowner.

"Clearly, the programs right now are not going to benefit a lot of individual homeowners," said Rick Sharga, vice president of marketing for RealtyTrac Inc. of Irvine, Calif.

Indeed, the latest figures from RealtyTrac show that foreclosure activity rose another 25% in October from the year-earlier period, with a whopping one in every 452 homes receiving a foreclosure notice last month.

3 MILLION AT RISK

Leading the charge for at-risk homeowner relief is Sheila Bair, chairman of the Federal Deposit Insurance Corp. She has been working feverishly to get the Fed to earmark $24.4 billion of the bailout proceeds to fund a loan guarantee program that would prevent up to 1.5 million people from losing their homes.

"As we lend and invest hundreds of billions of dollars to help institutions suffering leveraged losses from defaulting mortgages, we must also devote some of that money to fixing the front-end problem: too many unaffordable homes," she said in a statement.

Under Ms. Bair's program, the Department of the Treasury would offer federal guarantees to lenders who agreed to modify troubled loans by lowering the interest rate, principal or term of the loan to make monthly payments more affordable for the homeowner. Servicers would be paid $1,000 for each modified loan and the government would share up to 50% of the losses if the modified loans go into default.

Critics worry that Ms. Bair's program would encourage non- distressed homeowners to default to get lower monthly payments. However, Thomas Cooley, dean of New York University's Leonard N. Stern School of Business, said this problem could be eliminated if homeowners were required to share home appreciation with the lender when they sold the house.

Last week, the Bush administration unveiled a watered-down plan to help homeowners with delinquent mortgages that are backed by mortgage giants Fannie Mae of Washington and Freddie Mac of McLean, Va.

Under the plan, federal agencies would streamline the modification procedures for loans that are at least 90 days past due and make the monthly payment equal to about 38% of the homeowner's total income. This would be achieved by either stretching the term to 40 years, trimming the interest rate or deferring interest on the principal.

However, only a small fraction of homeowners — about 200,000 at most — could benefit from the program — a far cry from the 3 million facing foreclosure this year, according to figures supplied by RealtyTrac.

"This is a step in the right direction but falls short of what is needed to achieve wide-scale modifications of distressed mortgages, particularly those held in private-securitization trusts," Ms. Bair said.

Furthermore, experts said, voluntary programs such as the Federal Housing Administration's Hope for Homeowners program and state moratoriums don't go far enough.

States such as Massachusetts, California, Colorado, Maryland, New York and North Carolina have passed legislation requiring waiting periods of up to 90 days before a lender could foreclose on a property. This was aimed at en-couraging lenders to make loan modifications rather than foreclose on properties.

It hasn't worked.

In Massachusetts, for example, foreclosure activity slowed during the 90-day period but then spiked 465% in September when that period was up, according to RealtyTrac.

"It wasn't terribly useful," Mr. Sharga said. "A moratorium all by itself does nothing, but delay the inevitable."

A number of major banks, such as Bank of America Corp. of Charlotte, N.C., and Citigroup Inc. and JPMorgan Chase & Co., both of New York, have launched their own loan modification programs to help distressed homeowners avoid foreclosure. However, these initiatives apply only to loans held directly by these banks — not the millions of others that are securitized.

In the past, banks would make loans and hold on to them, said Bob Curran, managing director at Fitch Ratings Ltd. in New York. But for the past decade, most loans have been pooled together and sold as securities. As a result, "it's much more difficult to get at the holder of the mortgage instrument and get acquiescence on that," Mr. Curran said.

If a loan servicer unilaterally decides to modify a loan that's been securitized, the parties that own the mortgage instrument could take legal action, he said.

"We have not seen servicers participating in any significant way," House Financial Services Committee Chairman Barney Frank, D-Mass., said last week.

However, a move is under way by the American Securitization Forum in New York to bring together institutional owners of mortgage-backed securities to find a solution, said Tom Deutsch, deputy executive director.

Many industry experts are also pushing for federal assistance to jump-start the stalled homebuying market.

The National Association of Home Builders, a Washington trade group, believes that a stimulus package to encourage homebuying is needed to clear inventory and stabilize home prices.

It suggests that the government offer a tax credit of up to $22,000 to help buyers purchase a home and buy down the interest rate on conforming loans to make monthly mortgage payments more affordable.