Two limited federal housing policy interventions could avoid hundreds of thousands of foreclosures, help to stabilize home prices at a post-bubble lower level, and preclude more drastic intervention in the future, including direct government ownership of troubled assets. The first would prevent more foreclosures by facilitating the restructuring of some of the troubled but salvageable outstanding mortgages. The second would help to take foreclosed and abandoned properties out of the housing inventory where they depress sale prices and home values and put them to reuse as affordable housing.
Legislation to accomplish both of these goals is being marked up in committee in both the House and the Senate. We write to urge its rapid completion and broad support. We believe these bills, like any, could be improved, as detailed below. But our message is that the fundamental goal needs broad support, while changes are made as they make their way through the process. We do not have any time to waste.
Those who argue we must leave it to the market to find is natural level condone a continued vicious downward spiral of declining home prices, escalating foreclosures, rising losses on mortgage-backed securities, failing confidence in asset classes well beyond housing, and dwindling capital available for consumer credit, commercial real estate, and corporate debt. These are not abstract market harms.
The pain touches not simply those who got overextended, but also their many neighbors who happen to live down the street or around the corner from a foreclosed property, or increasingly, a slew of foreclosed or abandoned homes. The impact is most severe in our minority and lower income communities, although they are not alone. For average Americans who saw few if any wage gains from economic growth in recent years, the consequences of the economic slowdown driven by the housing crisis also include job losses, children who cannot go to college, families losing their homes, and evaporating retirement savings.
The Center for American Progress Action Fund brought together a group of our own experts and others who collectively boast decades of experience in economics, housing markets, financial institution regulation, and law. These analysts have no economic stake in this debate, but share a sense of urgency about the need to prevent greater harms to the broader U.S. economy and the families that make it up. We lay out below the case for these measures and improvements to the pending bills that would make them more effective.
We also refer you to a separate document, also released today and signed by a broad array of housing, civil rights, consumer, and labor organizations entitled: “Shared Agenda and Principles for Mortgage Market and Community Stabilization Policy.” While this memorandum is CAPAF’s alone, we note that the Shared Agenda demonstrates the commonality between the views of all these organizations—all of them committed to addressing the economic challenges shared by too many of America’s workers, consumers, people of color, and their communities. Below are our two key housing policy objectives.
Restructure Mortgages Quickly, and in Bulk, into Viable Affordable Loans
We must keep more existing owners in their homes, where possible, as a way to preclude the significant costs to families, increased housing inventories, and depressed values that come from foreclosure. As Ronald Reagan’s chief economic adviser Martin Feldstein recently opined in the Wall Street Journal, “Limiting the number of defaults, and preventing the overshooting of price declines, requires a public policy to reduce the number of homeowners who will slide into negative equity. Since house prices still have further to fall, this can only be done by a reduction in the value of mortgages.”
Federal credit enhancement, as offered by the Federal Housing Administration, is an essential tool to induce current or new owners to modify loans. If mortgage servicers modify loans today on behalf of investors, they are accepting that repayment will never be as great as once assumed, but they gain no assurance against further loss if housing prices fall or the borrower continues to be unable to repay. A federal government guarantee of the lower restructured loan, on fair, affordable, prudent and viable terms, is an important inducement to more loan refinancings.
We also must be vigilant to ensure the restructured loans are offered without discrimination, and that there is vigorous enforcement of the fair lending laws. And we believe another important incentive would be the knowledge that, when servicers are unwilling to restructure when feasible, there is a non-voluntary mechanism to modify individual loans in carefully targeted circumstances.
However, with time running out, it is not reasonable to imagine that we will get the level of restructuring necessary if handled piecemeal, loan-by-loan. Therefore, government also must create a mechanism for the bulk transfer of mortgages from one set of private owners to another. The role of government here is limited to setting the table for this transaction by conducting an auction to help find a new market-derived price, factoring in the availability of credit enhancement for the restructured loans.
As a result of the auction, these mortgages could be transferred from securitization trusts, in which the mortgage servicer has limited flexibility, unclear legal responsibility, and little economic incentive to restructure, to new holders without those barriers. The new purchaser would pay a discounted market price and newly restructured loans would benefit from the federal credit enhancement.
The purchasers of the loans would be responsible for helping homeowners stay in their homes with viable loans on responsible terms where possible. Servicers willing to refinance existing loans in bulk by offering new loans on the same responsible terms need not transfer their loans to a new party.
In contrast to the loan-by-loan mechanics currently incorporated in the legislation now before the House of Representatives, auctions could facilitate the refinancing of millions of mortgage loans in a timely manner to avoid unnecessary defaults, foreclosure, and more severe home price declines. An auction could quickly reprice existing mortgage pools and restore financial stability. Current investors in mortgage-backed securities of uncertain value could exchange them for new assets that boast the liquidity and reduced market risk of Treasury securities or cash. It is important to note that such an auction mechanism run under the auspices of the Treasury and/or Federal Reserve would not involve any taxpayer costs or risks.
The optimal way to prevent the problem of adverse selection is to require servicers to offer entire pools up for auction, with potential buyers evaluating the risk and valuation of the underlying mortgages and bidding accordingly. Some have raised concerns about the authority of servicers to sell loans or pools of mortgages. As we have argued elsewhere—see “Overcoming Legal Barriers to the Bulk Sale of At-Risk Mortgages”—there are options available to Congress to enable transfers of whole pools of loans and not just loan-by-loan decisions.
Reuse Foreclosed Properties for Affordable Homeownership and Rental Housing
Even if many foreclosures could be avoided, others are inevitable. Large numbers of foreclosed and abandoned properties will continue to drag down home values and community quality of life. State and local governments and their nonprofit partners are stepping in to stabilize communities, but they need flexible federal resources to support locally-appropriate reuse strategies for foreclosed properties.
Policies should aim to keep existing owners in their homes where possible, and support the acquisition and constructive reuse of foreclosed properties for affordable housing, through homeownership with viable mortgages on responsible terms, and through quality rental units, as well as the creation of other community assets.
This requires shared responsibility for solutions. Many share responsibility for the crisis and so must share responsibility for its solutions. Borrowers, lenders, investors, and the government must contribute and bear some of the cost of recovery. Specifically:
- No bailout for investors. Policies that help to stabilize the housing and credit markets are not aimed at softening the losses that flow from bad decisions by investors in risky mortgages, but on stabilizing families, communities, and the economy. Losses must be taken transparently to move forward. At the same time, action now to stabilize the situation and provide an effective and orderly path to resolution will minimize the risk of catastrophic losses throughout the economy fueled by market panic and overreaction.
- No windfall for homeowners. Homeowners who benefit from reduced balance loans or lower-than-market-price terms should share subsequent home price appreciation with taxpayers and credit providers. Soft second liens, shared equity, and other tools can be used to ensure some horizontal equity among homeowners.
- No participation by speculators. Resources should be focused on owner-occupants and not reward speculation by investors.
Analysis of Pending Congressional Proposals
The House Financial Services Committee is marking up two bills: H.R. 5830, the FHA Housing and Homeownership Retention Act, and H.R. 5818, the Neighborhood Stabilization Act of 2008. With some improvements, these two measures, taken together, will have a salubrious effect on both housing and credit markets. (Another memorandum will address pending Senate legislative proposals).
H.R. 5830: FHA Housing and Homeownership Retention Act
Keep the option of implementing a bulk mortgage transfer program, without further legislation, if the Federal Reserve and Treasury find it to be feasible. As currently drafted, H.R. 5830 focuses on providing credit enhancements as an incentive for servicer participation, while leaving open the possibility of future establishment of a bulk transfer mechanism to properly bring needed restructuring to scale. With upwards of two million mortgages likely to enter foreclosure (and with an additional million loans delinquent) this year, continued reliance on loan-by-loan modification will be insufficient to forestall housing market over-corrections or eliminate the fear and uncertainty that plagues Wall Street.
The language in the bill directing the Federal Reserve Board and Treasury Department to determine the feasibility of this approach is a good start, but we urge consideration of a mechanism that would enable these agencies to effect the results of their study without further congressional action. The fast-moving nature of the crisis argues for this accelerated policy development process.
Reliance on loan-by-loan decisions by servicers increases potential taxpayer exposure by creating an opportunity for cherry picking. By allowing servicers to string borrowers along, collecting fees all the while, and only proceed to FHA refinancing as a lower-cost alternative to filing for foreclosure, a program that should offer real assistance to distressed or soon-to-be distressed borrowers will instead end up providing a windfall to unscrupulous financial entities. Without rigorous program design to prevent such behavior, we run the risk of emulating the worst aspects of the Resolution Trust Corporation. We believe that bulk refinancing, ideally at the pool level, would eliminate many of these concerns.
Authorize GSEs to contribute to the solution. Despite the laudable effort to give FHA the much needed additional resources and flexibility required to implement the program quickly, we believe that, in addition to FHA, other existing conduits, including Fannie Mae, Freddie Mac, and the Federal Home Loan Banks, can also play a productive role and expand the reach of the program. Any program run through the GSEs would need to be accounted separately from the rest of GSE business. A multiplicity of conduits offers the best chance to ensure that the program can reach scale quickly, and avoids the risk of relying only on one mechanism for program success.
Clarify that the borrower need not default in order for the loan to be eligible for restructuring. Language in the legislation that requires the borrower to demonstrate that they have not "intentionally" defaulted could lead to an interpretation that only those loans in default could be refinanced through the new FHA program. We do not believe that is or should be the legislative intent. If the restructured loans were only available to defaulted borrowers, it would increase the risk of moral hazard and adverse selection by servicers. And it could exclude borrowers currently in good standing who have negative equity but for whom default is reasonably foreseeable based on the loan’s fully indexed rate as of a certain date prior to enactment. The problem of negative equity will be particularly pernicious for borrowers with so-called “option ARMs” who will be unable to refinance when their loans reset beginning in 2009. Program officials should have appropriate authority to adjust eligibility requirements over time consistent with clarified congressional intent.
Ensure refinanced mortgages are viable. The current bill would allow monthly payments of 43 percent to 50 percent of income in some circumstances. While we recognize that some of these borrowers are already heavily housing debt burdened, we have concern that such high ratios could make it challenging to sustain these refinanced mortgages. Program officers should have discretion to determine the circumstances when such high ratios are appropriate.
Use shared-equity to encourage broader participation. The credit enhancement is designed to work through the FHA. In addition, the insurance premiums, both at the time of origination and the ongoing annual fees under the refinancing program, are considerably higher than traditional FHA insurance.The high cost of obtaining credit enhancement, a 3 percent fee plus up to an additional 2 percent in closing costs paid by the original note holder, may prove too steep to attract broad participation by servicers. The fee might be reduced in exchange for FHA taking an additional portion of upside potential from shared-equity soft second loans on the properties insured by FHA.
H.R. 5818: The Neighborhood Stabilization Act
Level of resources provided. Community stabilization through restoring foreclosed properties to productive use is as crucial to restoring normal functioning to local housing markets as foreclosure prevention. The $15 billion offered in the Waters bill more adequately reflects the collective and growing needs of American communities nationally than lower levels funded in the Senate so far to date.
Loan mechanism could impede essential bulk purchase of properties. We are deeply concerned that offering the funds as a combination of grants and loans as opposed to grants exclusively will severely hamper the ability of non-government organizations to put deals together for the bulk purchases of properties. Moreover, we have significant reservations about the capacity of the Department of Housing and Urban Development to process loans in a timely fashion or administer the program effectively. If it is necessary to offer a combination of loans and grants, then the loans would best be underwritten and originated by states and localities with their proven track records of lending CDBG and HOME funds.
Target resources to impacted areas. While the problem of declining house prices is national in scope, not all localities or neighborhoods have been impacted to the same degree. We know that women and minorities were more likely to have been offered subprime loans than other groups, and that foreclosures are often concentrated in low- and moderate-income communities. With that in mind, it is imperative that funds be allocated to the places that have been most impacted with respect to subprime lending, delinquencies, and foreclosures. Simply allocating funds to the states based on their overall need will not guarantee that funds will flow to the communities most in need of assistance. Impact should be ascertained not only as a function of absolute numbers but also as a ratio of total housing stock or owner-occupied homes. We suggest following an allocation formula similar to that adopted by NeighborWorks America for distributing counseling funds to areas of greatest need.
Avoid requirements on how resources may be used. Flexibility in the use of the Community Development Block Grant funding is crucial to the success of the program, as local needs will vary considerably. The legislation being considered strikes a balance between allowed uses and not providing no-strings-attached assistance to local government, but it should take into account that foreclosed properties will, in many cases, require significant rehabilitation and excessive restrictions on the use of grants may limit program efficacy. With that in mind, we must also make sure not to try to do too much with these funds. As with all cases of allocating scarce federal resources, the need for balance must be recognized. Thus, while some funds should be made available to help extremely low-income households, many of whom are renters, the thrust of the legislation is designed to assist homeowners (at a variety of income levels) in neighborhoods facing blight. The bulk of the funds should be used to that end. The language on income targeting makes it difficult in many cases to fully leverage funds available, as non-profits have no way of knowing in advance who may seek to purchase a home that has been rehabilitated. Income targeting is always a component of statutorily defined affordable housing, but very specific targets may hamper the speed and efficacy of the program.
Be realistic about the extent of scattered site rental feasible. While use of the funds to redevelop bank-owned properties as rentals may make sense in a limited number of cases, there are only a relatively small number of housing intermediaries who have the capacity to manage scattered-site rentals well. Moreover, the cost of rehabilitating foreclosed-upon real estate-owned properties to housing-market quality standards (or at a minimum, local code) is expected to be significant, as vacant properties are soon stripped of appliances, plumbing, and even wiring. Sale of the property, even on an affordable basis, becomes necessary to recycle funds for the purchase of additional properties. The cash flow generated by renting these properties will not be enough to allow these funds to be used multiple times over as envisioned by most proponents of the program, nor will it support a loan program.