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For housing, no easy fix

Taxpayer funds prop up the banking sector, but there are no easy solutions for the foreclosure mess.

By Colin Barr, senior writer
Last Updated: October 24, 2008: 9:49 AM ET

NEW YORK (Fortune) -- Calls for a sweeping federal response to the housing mess are getting louder. But finding a solution isn't getting any easier.

Sheila Bair, the chairman of the ederal Deposit Insurance Corp., said Thursday that the feds are considering guaranteeing payments on some troubled mortgages. The move, she told members of the Senate Banking Committee, would aim to reduce foreclosures by pushing investors and lenders to agree to restructure loans.

While such an outcome would no doubt keep some residents in their homes, it's worth noting that the government has yet to put forth any proposal that approaches what it has done in the financial sector. There the feds plan to pour $125 billion into nine big banks including Citi, Goldman and Bank of America and promise to backstop the markets for short-term commercial borrowing and bank debt, among other things.

So far, government support for homeowners has been limited to a few modest foreclosure-reduction and mortgage-refinancing plans. But with tens of thousands of jobs being lost every month, the decline of values in the housing market - the biggest source of Americans' personal wealth - is weighing even more heavily on the economy. House prices have fallen 17% over the past year, according to S&P/Case-Shiller data. Foreclosure filings rose 71% from a year ago in the third quarter.

The missing piece

The government's failure to act pre-emptively and decisively on the housing crunch has only added to the problem, says University of Michigan law professor Michael Barr.

"The administration should have acted a year ago," says Barr, who is a senior fellow at the Center for American Progress. "Doing something for homeowners is the key missing piece of the response to this crisis."

The comments Thursday by FDIC chief Bair suggest that the government's first priority is to speed the restructuring of troubled loans. But there are numerous hurdles to loan workouts, not the least of which is that some borrowers may simply have bought houses they couldn't afford no matter the terms of their loan.

Beyond that, Barr points to the tax and accounting implications of removing mortgages from the securitization trusts where many loans reside after being sold to investors, for instance.

Barr and colleagues at the Center for American Progress have advocated that the government buy pools of mortgage loans at what he calls a market-determined discount, then refinance troubled mortgages within the pools to allow homeowners to stay in their houses.

"Our plan is designed not just to help out those facing foreclosures," he told the Senate Banking Committee in January, "but to contain the severe contagion effects of foreclosures on property values; consumer credit, spending, and confidence; commercial real estate markets; and the functioning of credit markets."

Such a sweeping bailout plan could prove many times more expensive than effors to date have been.

Still, given the scale of the crisis, a piecemeal approach to restructuring mortgages may not be enough. Olivier Garret, CEO of Casey Research in Stowe, Vt., says millions of homeowners could end up in trouble in a deep recession, because they bought houses during a decade when prices essentially doubled even as incomes were flat.

Now, prices are moving back into their historic relationship with rents, which will leave many borrowers - whether designated subprime or prime according to credit scores - owing more than their houses are worth.

"Look at the scope of the problem," says Garret.

Will banks play ball?

New York University finance professor Stephen Figlewski sees another issue, which is that some lenders and mortgage investors still may not want to restructure their loans. Modifications are typically billed as being less costly than foreclosures, particularly given the poor resale prospects for seized houses in the glutted housing markets of today. Even so, some may prefer to hold out rather than accept losses now.

"Incentivizing lenders to restructure loans is fine," says Figlewski. "But it's not making them do it."

Figlewski says it's tough to devise a housing rescue plan in large part because there's no consensus on how the burden of falling house prices should be shared.

Should lenders and investors have to take substantial losses, as envisioned in, for instance, the FHA Secure refinancing plan that was enacted earlier this year? Or should the government consider an approach that would guarantee mortgage payments across the board, and then leave taxpayers on the hook for losses taken in any mortgage restructurings?

Either way, there's more pain ahead for both lenders and homeowners. Even after the declines of recent years, the cost of buying a house in many areas remains well above the price of a comparable rental.

"The underlying value isn't there," says Garret of Casey Research. "A repricing of housing assets is absolutely necessary."  To top of page

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