Mortgage crisis: Don't forgive debt, just postpone repayment

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Prices may be falling in places like Cleveland, but buying a house is still far out of reach for most people. Play video

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NEW YORK (CNNMoney.com) -- A plan that would help troubled mortgage borrowers today - and might make lenders whole later on - was unveiled Wednesday in Washington.

The Office of Thrift Supervision (OTS) is urging the federal savings and loans lenders under its authority to refinance loans by reducing mortgage balances to the current market values of the homes. Thanks to falling home prices, many homeowners are now stuck with mortgages that are actually worth more than the houses themselves.

But instead of having lenders forgive the difference between the old mortgage and a house's current resale value, called a short sale, the OTS advises that lenders issue a warrant or "negative amortization certificate" for the difference. If a home regains its market value and is then sold, lenders have first claims to the profits.

"If a house has a $100,000 mortgage originally," said Bill Ruberry, a press spokesman for the agency, "and the fair market value is $80,000, there's $20,000 in negative equity. The lender could refinance for $80,000 and a warrant [for the $20,000 in lost value]."

If the house later sold for $100,000, the lender would collect the $80,000 mortgage balance plus the $20,000. If the sale realized more than $100,000, the certificate holder might even get interest on top of the $20,000. Any profit beyond that would go to the borrower. The warrants could be publicly traded.

The hope is that this plan will help prevent foreclosures while minimizing the hit that lenders will take, all without putting any burden on the taxpayers.

All borrowers are likely to be eligible, according to Jaret Seiberg of the Stanford Group, a policy research company, but the proposal appears to be aimed at those with subprime ARMs, negative amortization mortgages and interest-only mortgage borrowers. They're the ones most likely to have negative equity.

The savings and loan industry, which held 31% of mortgage loans last year, saw record losses of $5.24 billion for the fourth quarter of 2007, according to the OTS.

Few details about the plan have been settled, but it would not involve any legislation, nor would it be mandated in any way. Adoption would be on a voluntary basis by the hundreds of thrift institutions in the United States, like Washington Mutual (WASH) and IndyMac Bancorp (IMB).

Indeed, banks may not want to take this approach in markets where prices have fallen so steeply that it is unlikely they'll recover any money.

The plan's biggest attraction for lenders, according to Seiberg, is that rather than spending $50,000 to foreclose on a home or to write-off the negative amortization in a short-sale, they get a certificate that permits them to share in the up-side, if and when housing markets recover.

"The plan still needs to be discussed, but it has some attractions," said Ruberry. "We're putting it out there and urging our institutions to give it a look."