The mortgage dilemma

Despite efforts by the federal government and the private sector, foreclosures are still on the rise. The Bush administration is under pressure to do more about the problem, and the latest statements from senior officials suggest that it will soon try. In part, this reflects election-year politics: Having authorized hundreds of billions of dollars to rescue banks, Congress and the president can hardly seem to dismiss homeowners. But there are legitimate social and economic reasons to limit foreclosures. Foreclosures not only cost families their homes, they drive down the property values of whole neighborhoods. And since sinking home prices triggered the financial crisis, the more that can be done to stop their downward spiral, the better.

This is much more easier said than done, however. Every proposal to arrest the wave of foreclosures faces the same dilemma. If you offer a new and better deal to some distressed homeowners, you give homeowners who are not in distress an incentive to seek the same deal. At the margin, people who are, or could be, current on their loans would go into arrears to qualify for a loan modification. A broad plan might prop up house prices generally, at the cost, financial and moral, of putting taxpayers on the hook for borrowers who could make it on their own. A narrow plan would be fairer to taxpayers but lift home prices only modestly.

This is why the results of voluntary efforts to modify troubled subprime loans, such as the Treasury-supported Hope Now program, have been relatively meager. Lenders work case by case lest they encourage unnecessary defaults. The Hope for Homeownership program, which went into effect Oct. 1, was also probably oversold. It offered $300 billion worth of federally guaranteed refinancings for borrowers who met certain eligibility criteria. But since it also required both borrowers and lenders to take a financial "haircut" in return for the help, there may not be many takers.

Which brings us to the notion sketched by Sheila C. Bair, chairwoman of the Federal Deposit Insurance Corp. She suggested last week that the government set out a standardized loan modification package for loan servicers to follow, enabling them to do workouts faster. In return for their picking up the pace, the government would guarantee some or all of the newly modified loans. By offering a strong material incentive to lenders, Bair's concept addresses one of the weaknesses of previous proposals. It is not yet clear, however, how it would shield servicers from potential lawsuits by disgruntled investors who own loans via securities. To be acceptable at all, the proposal must limit relief to a particular set of troubled, low- or moderate-income borrowers who have had their loans for some time. It would be dangerous to extend it to recent or future borrowers. But if there was a simple and fair way to get relief to homeowners, it probably would have turned up by now.

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