Against the tide

Any plan to shore up the U.S. housing market and prevent foreclosures confronts a basic dilemma.

To maximize a plan's effectiveness, the government must confer significant benefits on a large number of homeowners. To maximize fairness and conserve funds, the government must NOT confer benefits on anyone who doesn't really need or deserve help, or on those who will default even on more generous mortgages.

In confronting this trade-off, President Obama is no different from the many others before him — President George W. Bush, various members of Congress and countless economists — who have tried to devise a solution. This week, Obama argued that his new Homeowner Affordability and Stability Plan will be comprehensive enough to protect neighborhoods across the country from the negative consequences of foreclosures. At the same time, he said, the plan "focuses on rescuing families who have played by the rules and acted responsibly."

Will it succeed? The plan would permit Fannie Mae and Freddie Mac, newly fortified with a $200 billion capital infusion, to modify mortgages for homeowners who owe between 80 and 105 percent of the market value of their houses. Additionally, using $75 billion derived mostly from the Treasury Department's financial bailout fund, Obama is offering subsidies to loan servicers — plus cash incentives of as much as $1,000 per mortgage — to reduce monthly payments to as low as 31 percent of a borrower's income. Borrowers would be eligible for up to $5,000 if they managed to stay current on their modified loans for five years. Combined, these measures could help 7 million to 9 million homeowners refinance and save hundreds or thousands of dollars per year, thus reducing their chances of foreclosure, the administration says.

The plan wisely focuses on preventing salvageable mortgages from going bad, rather than promising a lifeline to every subprime borrower. It also is an improvement over past efforts in that it offers servicers an incentive to rewrite loans; this might spur some to overcome mortgage-security investors' resistance to modifications. J.P. Morgan Chase chief executive Jamie Dimon said this week that the plan could help his company rewrite more than a million mortgages.

In tailoring his plan to those deemed most deserving and capable, Obama necessarily reduced its potential impact. Also, the benefits it provides could turn out to be relatively modest, depending on each borrower's situation. More and more people are facing foreclosure not because they took out subprime loans with unaffordable interest "resets" but because they lost their jobs and can't pay mortgages of any kind. Their monthly payments in many cases account for well above 50 percent of their monthly incomes. Yet, under the Obama plan, lenders would have to reduce that ratio to 38 percent before the government subsidy kicks in. And the subsidy would be limited to half the cost of lowering the ratio from 38 percent to 31 percent. On many loans, that simply won't be a better deal (for the lender) than foreclosure.

And, of course, homeowners may default on even dramatically cheaper loans if they suddenly lose their jobs — notwithstanding the Obama plan's incentives for them to stay current. Bank of America, for example, already has a program to reduce borrowers' payment burdens to 34 percent of income. But, as The Post's Renae Merle recently reported, many redefaulted when they became unemployed. Moments after Obama finished his speech, the president of the Federal Reserve Bank of Chicago forecast that unemployment will continue to rise through the middle of next year.

The bottom line is that Obama has negotiated the trade-offs cautiously. His plan offers more relief than previous programs, and targets it. Cutting some homeowners' borrowing costs could help them stay in their homes as long as they still have work. The plan pushes back against the recessionary tide. But that tide is still rising.

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