Alternative Proposals to Stem Subprime Foreclosures
News that foreclosures reached a record high in the fourth quarter has underscored the need for action to stem the tide. The big question is how.
While banks and other lenders argue that current proposals risk driving up the cost of borrowing for all, others see the plans as helping lenders more than borrowers.
Among the latter is the Center for Economic and Policy Research. A new paper from the think tank claims that most subprime rescue plans are really little more than “backdoor bank bailouts.”
The CEPR says that under plans similar to those put forward by the Office of Thrift Supervision, “homeowners will get to keep their house, but will be paying 85 percent more than if they rented a similar property. They will have little hope of accruing equity in a house that is falling in price and in which the initial terms of the mortgage have already put them underwater. Furthermore, depending on the rate of foreclosure, taxpayers could plausibly end up paying as much as $75,000 for each homeowner who stays in their home. ”
Instead, CEPR advocates a rent-to-own solution.
If foreclosure rules were temporarily altered, to give moderate-income homeowners facing foreclosure the option to rent their home at the fair market rent, it would provide a large element of security to the millions of moderate-income families at risk of losing their home.
Furthermore, the paper says, this temporary change in foreclosure rules would provide a very strong incentive to lenders (who do not want to become landlords) to negotiate terms under which homeowners can stay in their house as homeowners. “This plan also has the advantage that it requires no government money and no new bureaucracy.”
Martin Feldstein, chairman of the Council of Economic Advisers under President Reagan also says none of the current mortgage-reduction proposals are satisfactory. Writing in the Wall Street Journal, Feldstein says, “Although bankers sometimes have the incentive to reduce mortgage-loan balances voluntarily in order to avoid a foreclosure, this is usually not possible because the syndication of mortgage loans means that there is generally not a single lender who can agree to the mortgage writedown. ” Instead, he advocates a loan substitution program.
Although there is no perfect plan, a program of federal mortgage-paydown loans to individuals, secured by future income rather than by a formal mortgage, could reduce the number of mortgages with high LTV ratios and cut future defaults.
Under Feldstein’s proposal, “The federal government would lend each participant 20% of that individual’s current mortgage, with a 15-year payback period and an adjustable interest rate based on what the government pays on two-year Treasury debt (now just 1.6%). The loan proceeds would immediately reduce the borrower’s primary mortgage, cutting interest and principal payments by 20%. Participation in the program would be voluntary and participants could prepay the government loan at any time.”
“The legislation creating these loans would stipulate that the interest payments would be, like mortgage interest, tax deductible. Individuals who accept the government loan would be precluded from increasing the value of their existing mortgage debt. The legislation would also provide that the government must be repaid before any creditor other than the mortgage lenders.”
Federal Reserve Chairman Ben Bernanke’s proposal that banks reduce the principal owed by borrowers has been controversial. The Motley Fool argues both sides of the debate.
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