How to Stop the Foreclosures
A Review of the Policy Proposals by Fred Moseley
This article previously appeared in Dollars and Sense.
"Homeowners should be allowed to stay in their homes; and
there should be no bailouts for the lenders."
Over one million U.S. homeowners have already lost their
homes due to foreclosures since the mortgage crisis began last summer. Another
one million homeowners are 90 days past due on their mortgages (foreclosure
notices usually go out after 90 days) and two million more are 30 days past
due, so three million more households may face foreclosure in the months ahead.
If current policies do not change, it is estimated that up to five million
homeowners would lose their homes due to foreclosure over the next few years.
Five million is roughly 10% of the total number of homes with mortgages. This
is clearly the worst housing crisis since the Great Depression, and will wreak
havoc in the lives of millions of families unless something is done. A high
foreclosure rate also has a deteriorating effect on surrounding neighborhoods,
further depressing housing prices and quality of life.
Many of those facing foreclosure are low- to middle-income
homeowners who were enticed into buying houses by fraudulent mortgage companies
and low "teaser" interest rates that are adjusted up ("reset") after two to
three years. As long as housing prices were increasing, homeowners could always
refinance their mortgages and get a new teaser rate for another few years.
However, now that house prices are falling, these homeowners can no longer
refinance, and many of them cannot afford to pay the higher interest rates when
they are reset. Falling prices also mean that many of these homeowners owe more
on their mortgage than the current value of their house (i.e. they have
"negative equity" in their house). The recession is also resulting in declining
employment and income, meaning even more homeowners are struggling to make
their monthly mortgage payments. The further housing prices decline, and the
worse the recession is, the worse the foreclosures will be, in a vicious cycle.
"At a minimum, policies
should apply only to owner-occupied homes, and not to "investor" or
‘speculative' homeowners."
Clearly, the federal government must take some positive
actions to stop the spreading foreclosures, especially for low- and
middle-income families, who would suffer the most. But what should those
actions be? At a minimum, policies should apply only to owner-occupied homes,
and not to "investor" or "speculative" homeowners (those who buy houses in
order to sell them later at a higher price). But beyond this, various policies
have been proposed, and not all of them would truly help homeowners at risk.
Workouts, not bailouts
"If someone has to suffer losses now, it should be the
lenders."
There are two main types of anti-foreclosure policies:
bailouts and workouts. In bailouts, the government gives aid either to lenders
(e.g. by purchasing bad mortgages at their full original value) or to
homeowners (e.g. by giving them loans so they can repay their lenders). Of
course, aid to homeowners indirectly bails out the lenders as well. In
workouts, the terms of the original mortgage contract are modified, either by
reducing the rate of interest or reducing the principal owed, or both, in order
to make the loan more affordable. So far, most of the proposals to deal with
the foreclosure crisis have been more workouts than bailouts, although there
are elements of bailout in some of them as well. The lenders made fortunes on
these risky mortgages during the housing bubble, so if someone has to suffer
losses now, it should be the lenders. There should be no bailouts of the
lenders in any way.
Lender-initiated workouts
There are two types of workouts, depending on whether they
are initiated by the lenders or the homeowners. Most of the policies proposed
and enacted so far have been initiated by the lenders, i.e., they are voluntary
on the part of the lenders. The main policy of the Bush administration is
called "Hope Now," in which the lenders voluntarily postpone the resets of
interest rates that are scheduled to take place in the months ahead, and leave
the principal of the loan unchanged (or sometimes the foregone interest is added
to the principal). The Bush administration claims that over 500,000 mortgages
have been modified in this way in recent months, and estimates that another
500,000 mortgages will be modified in the months ahead. However, critics argue
that these numbers are exaggerated and that many of these modifications have
been simply allowing homeowners more time to make the same payments. It is
likely that in the months ahead, many of these homeowners still will not be
able to make their payments, and many of them will be foreclosed on, which has
led some critics to call this the "No Hope" plan. The only lasting solution is
to reduce the mortgage principal owed to more affordable levels. The main
problem now is not the reset of interest rates, but rather declining housing
prices, which has the effect that more and more homeowners now owe more money
on their mortgage than their house is worth.
"The only lasting solution is to reduce the mortgage
principal owed to more affordable levels."
The House of Representatives has recently passed a bill
(H.R. 5830, introduced by Rep. Barney Frank, D-Mass.) that is primarily a
workout, but also is potentially part bailout, and is also lender-initiated The
bill would replace existing mortgages with new mortgages that would have a value
of 85% of the current market value of the houses, and these refinanced
mortgages would be guaranteed by the Federal Housing Administration (how this
"current market value" is to be determined is a crucial detail which so far has
not been specified). This 15% "write-down" of the principal, plus the prior 10%
decline of prices means that the total write-down for lenders will be
approximately 25%. For example, a homeowner with an original mortgage of
$300,000 would have the principal reduced to $225,000, and the monthly payments
reduced by a similar proportion. The bill appropriates $300 billion for this
purpose, which it estimates could help up to 1.5 million homeowners. A similar
bill appears likely to pass in the Senate (introduced by Christopher Dodd,
D-Conn.). President Bush initially threatened a veto, but has now said he will
sign the bill. In any case, it does not appear likely that many lenders will
"volunteer" for this writedown.
Another problem with this bill is that housing prices in
some areas are likely to fall more than an additional 15%. Mortgages on these
houses are likely to be the ones that the lenders will voluntarily refinance,
and any further losses would have be borne by the government (i.e., by the
taxpayers). This would be a partial bailout of the lenders.
Homeowner-initiated workouts
Another bill has been introduced into the House (H.R. 3609)
and Senate (S. 26360) that would provide workouts that would be initiated by
the homeowners and would be mandatory for the lenders. These bills would allow
bankruptcy judges to modify mortgage contracts (by reducing the principal
and/or by reducing the interest rate) in order to make monthly payments more
affordable for homeowners. It used to be possible for bankruptcy judges to
modify mortgage contracts, but this was explicitly prohibited in a 1993
bankruptcy law. One can see the hand of the mortgage bankers in the writing of
that provision. Modifications on other types of loans are allowed: for
investment properties, for vacation homes, and even for boats, but no
modifications allowed for primary residences! So all that needs to be done is
to delete this one phrase in the law which prohibits modifications for primary
residences. A significant advantage of this plan is that it would not cost
taxpayers anything.
One problem with this bill is that homeowners would have
to declare bankruptcy, which is expensive (about $2000) and would hurt their
credit rating in the future. But at least they would still have their home,
with an affordable mortgage, and thus would have the chance to restore their
credit rating.
This bill is supported by the AFL-CIO, SEIU, NAACP, ACORN,
the Center for Responsible Lending, and many other consumer protection groups.
It is of course strongly opposed by the Mortgage Bankers Association, and does
not seem to have enough support for passage at the present time.
"Homeowners faced with foreclosure would have the option
to stay in their houses as tenants, rather than as owners, and would pay the
prevailing rental rates."
Another homeowner-initiated plan has been proposed by Dean
Baker of the Center for Economic and Policy Research. According to this
"own-to-rent" plan, homeowners faced with foreclosure would have the option to
stay in their houses as tenants, rather than as owners, and would pay the
prevailing rental rates, which are generally much lower than mortgage payments.
Eligibility for the plan would be capped at the median house price in a
metropolitan area and thus would not benefit high-income homeowners. This plan
also would not cost taxpayers anything. A bill along these lines was recently
introduced in the House (H.R. 6116).
Looking ahead
The presidential candidates have had disappointingly little
to say about the foreclosure crisis and anti-foreclosure policies. Senator
Barack Obama has expressed support for the Frank-Dodd FHA bill, but not yet for
the bankruptcy modification bill. In good Republican tradition, McCain
advocates "no government intervention." But the foreclosure crisis is likely to
worsen in the coming months, and the public may well demand more policies to
address this growing problem. The homeowner-initiated policies are preferable
because they provide the most protection for homeowners against foreclosure.
Both of these options should be available to homeowners facing foreclosure,
especially for those with low or moderate incomes.
The guiding principles of government anti-foreclosure
policies should be: (1) homeowners should be allowed to stay in their homes;
and (2) there should be no bailouts for the lenders. And the long-run objective
of government housing policies should be: decent affordable housing for all.
Fred Moseley is a professor of economics at Mount Holyoke
College. His publications include The Falling Rate of Profit in the
Postwar United States Economy (1992) and "The Rate of Profit and the Future
of Capitalism," Review of Radical Political Economics, 1997.
Resources: For more information about H.R. 3609
and S. 26360, visit the website of the Center for Responsible
Lending. For more information about Dean Baker's "own-to-rent" plan
(introduced in the House as H.R. 6116), visit the website of the Center for Economic and Policy
Research.