Calls widen for broader foreclosure solutions

Those servicers are reluctant to reduce a borrower's principal or interest rate for fear of being sued by investors who would see lower returns on their mortgage-backed securities. Though those investors may ultimately lose more if the underlying loans default, it’s impossible to predict just how many mortgages will stop paying. If interest rates fall and the housing market recovers, investors could later argue in court that servicers should have taken a harder line on modifying loans.

Negotiations between homeowners and lenders are also hampered by the widespread use of so-called “piggyback” loans — second mortgages that were used to finance nearly 40 percent of home purchase in 2006. Both lenders in such a case typically need to agree to a loan modification.

But if the total amount of loans outstanding is greater than the value of the house, the first mortgage is paid off first when the home is sold, often leaving the holder of the second mortgage with nothing. So many second mortgage holders figure they have nothing to lose by rejecting modifications and hoping the homeowner figures out how to make their payments long enough for housing prices to recover.

Unfortunately, the ongoing erosion of home equity will likely make matters worse before they get better. Homeowners' percentage of equity slipped to a revised lower 49.6 percent in the second quarter of 2007, according to the Federal Reserve's quarterly U.S. Flow of Funds Accounts, and declined further to 47.9 percent in the fourth quarter — the third straight quarter it was under 50 percent.

The total value of equity also fell for the third straight quarter to $9.65 trillion from a downwardly revised $9.93 trillion in the third quarter.

Home equity, which is equal to the percentage of a home's market value minus mortgage-related debt, has steadily decreased even as home prices jumped earlier this decade due to a surge in cash-out refinances, home equity loans and lines of credit and an increase in 100 percent or more home financing.

All of which has some officials calling for more drastic measures.

The most recent came from Bernanke who offered the banker's group tough medicine: He asked them to forgive some of the principal on loans in which homeowners have little or no equity.

“When the mortgage is ‘under water’ a reduction in principal may increase the expected payoff by reducing the risk of default and foreclosure,’ said Bernanke. But “temporary palliatives … may only put off foreclosure and perhaps increase the ultimate costs.”

Another idea, championed by Sheila Bair, Chairman of the Federal Deposit Insurance Corp., would involve an across-the-broad freeze on interest rates that are scheduled to jump to above-market rates and create unsustainable monthly payments. She has criticized temporary loan modifications as “kicking the can down the road” if they don’t provide long-term solutions.

Congress recently expanded the borrowing limits for government-sponsored agencies Fannie Mae and Freddie Mac to provide more capital to the mortgage markets. But those measures won’t help existing homeowners with too little home equity to qualify for a conventional refinancing.

Others have suggested creating a new agency — similar to the Resolution Trust Corp. created after the savings and loan collapse of the 1980s, or the Depression-era Home Owners' Loan Corp. that bought out troubled loans from lenders and replaced them with new, more affordable loans for borrowers.

So far, political opposition to a “bailout” has prevented broad government intervention. Last week, Treasury Secretary Hank Paulson repeated the White House’s opposition to using taxpayer dollars to provide relief, saying lenders should be allowed time to work out solutions on their own. But even if the political wind shifts soon, relief probably won’t come soon enough for hundreds of thousands of homeowners.

“It's too late to try to create a new agency, and then build it, staff it up, train the staff appropriate for it and try to address this,” said Taylor. “That’s going to take a year. We don’t have another year of 200,000 foreclosures a month."

That, he said, is a "guarantee" for a recession.

All of these proposals face a fundamental hurdle: the backlash from homeowners who are struggling but still keeping up with their payments. With no standard guidelines for who qualifies for a break on their loans, home buyers who didn’t get in over their heads will want to know why they can’t get a break from their lender too.

"The challenge comes in when the existing homeowners are performing and they want similar reduction in loan amounts and feel punished for making their payments,” said Michael Zoretich, vice president of CK Mortgage, a mortgage brokerage in Brookings, Ore. “They may view the failing borrower as receiving rewards not offered to them.”

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