Foreclosing Foreclosures: Mitigating the Housing Crisis

Signs of distress abound in the U.S. economy. Gross domestic product (GDP) growth has slowed abruptly over the last six months - the growth figure for July-September 2007 was 4.9 percent; the equivalent figure for October-December of the same year was 0.6 percent. Inflation for basic consumer goods is about 10 percent over the last year. Some parts of the country are seeing a price of $4 a gallon or higher for gasoline. The capital markets have lost upward of 10 percent of their value since the beginning of the year.

At the vortex of the nation's economic slowdown (we'll be able to say "contraction" when we get the GDP growth figure for the first quarter of 2008 and "recession" when we get the GDP growth figure for the second quarter) is the spreading subprime housing crisis. The value of the American home in the 20 largest metro areas in the nation showed price declines fell by over nine percent in 2007, the largest annual decrease since the early 1970s. Housing permits in December 2007 were 34.4 percent below the level of December 2006, and the number of housing starts was 38.8 percent lower - the largest declines since January and February 1991, respectively.

Most menacing, however, is the rapidly increasing rate of foreclosures and the projection of up to three million more foreclosures over the next couple of years. The corrosive effect of foreclosures is not just a matter of devastated personal finances (the vast majority of all American families' equity is based on the value of the homes they own), but of vandalism, arson, even drug trafficking in vacant homes, leading to a further downward spiraling of neighborhood home values and still more foreclosures.

How can this cycle be stopped before millions of American families lose their homes? If the federal government is going to be part of the solution, political reality - regardless of economic exigency - will require the following of any plan:

• It cannot involve "massive government intervention," or it risks the threat of veto by President Bush
  
• It must pay for itself or include offsetting tax hikes or spending cuts to comply with the pay-as-you-go (PAYGO) constraints Congress has imposed on itself
• It cannot involve a bailout of either financial institutions or investors who have lent to homeowners or to homeowners who have borrowed, except perhaps in "predatory" cases, since "bailout" is a dirty word, connoting taxpayer exploitation

One might also add that simplicity and a catchy name would be helpful for any such plan.

A proposal floated by House Financial Services Committee Chair Barney Frank (D-MA) manages to meet all of the above criteria - except for the last. Still, the "FHA Housing Stabilization and Homeownership Retention Act of 2008" (FHAHSAHRA), avoids all political and legislative minefields and could forestall over half of the foreclosures otherwise projected to occur over the next 18 months.

Here's how it works: The Frank bill would permit the Federal Housing Administration HA to provide up to $300 billion in loan guarantees that would help to refinance at-risk borrowers into viable mortgages. Existing lenders or mortgage holders would avoid the 40 cents-on-the-dollar-plus losses they could otherwise expect, in exchange for the accepting an auction-determined write-down of principal likely in the realm of 30-35 cents-on-the-dollar and will have no further credit exposure to the borrower, if the restructured loan is one the borrower can reasonably be expected to pay.

Both borrowers and lenders would pay a premium to the government in return for the FHA loan guarantee. These payments would bring the aggregate cost of the program down to negligible amounts - $10 billion over five years in the worst case, a profit for the government in the best. The Frank plan could potentially refinance between one and two million loans (and help these families stay in their homes), protect neighborhoods, and help stabilize the housing market.

Because the government outlay (or "intervention") is minimal, the plan is likely to find favor with the Bush administration. And because the premiums will come close to covering government costs, the plan is expected to be practically PAYGO compliant without need for more than minimal offset provisions. Finally, no one could fairly characterize the plan as a bailout for anyone. Lenders would suffer the losses of substantial write-downs, and borrowers would pay penalties on any profits from reselling.

The stakes to the economy and to American families are high and the timing tight. But the guess here is that Congress will act swiftly upon its return from its Easter recess, and the administration will not interpose ideological objections to the plan. By mid-May, the Frank plan could be signed and take effect, and the battle against the true source of the nation's current economic woes will be joined.