The race to rescue subprimes

The mortgage industry must move faster to clean up its mess to avoid tougher regulations by Congress.

from the October 24, 2007 edition

Anyone claiming an easy fix to America's mortgage crisis may also want to sell you a low-interest, no-down-payment subprime loan. Yet solutions are needed, and quickly, to rescue many people on the brink of foreclosure and to reduce the economic drag of a housing recession.

The best solutions, and the ultimate ones, are slowly being implemented by companies that hold the bad loans. They've felt the effects so far of 2.2 million people forced to foreclose on subprime mortgages. The costs to the industry and its investors are estimated to be about $164 billion. By 2009, another 2 million homeowners could default as higher interest on subprime loans kick in.

That provides a strong incentive for private correction rather than government intervention.

At all levels of this complex industry, pressure remains strong to reassess vulnerable loans and keep them afloat. This will help not only homeowners who can still afford a home loan – if given a break – but also help financial investors know the true value of the "bundles" of such mortgages that were resold as securities.

But the pace of cleanup has been far too slow as foreclosures continue to cascade. That forced Treasury Secretary Hank Paulson last week to cite an "immediate need" for lenders to move more quickly in modifying and refinancing loans. He's working with the nation's largest mortgage services to reach out to struggling homeowners. He also helped several large financial institutions set up a $75 billion "superfund" to ease credit problems caused by the uncertainties of mortgage investments.

Such steps by the Bush administration are being echoed in the states, with some asking banks to accept greater losses in a foreclosure. Many attorneys general and state bank regulators are arm-twisting lenders to offer better terms to vulnerable homeowners.

Unless industry corrections begin to ease this crisis, the mortgage business faces the prospect of new laws that will tighten regulations and perhaps reduce the availability of mortgages to worthy would-be home buyers.

Reforming the industry is already an issue in the presidential campaign. And this week, the chairman of the House Financial Services Committee, Barney Frank (D) of Massachusetts, introduced a bill that would place a heavy burden on the mortgage industry.

Mr. Frank wants to hold mortgage sellers, not buyers, responsible for assessing whether a buyer can "reasonably" afford a loan, based on that person's income, debt, and credit scores. Almost every seller does that already. But during the subprime craze, many mortgage brokers didn't. Under Mr. Frank's bill, they could be sued by buyers who claim they didn't know what kind of monthly payments they would afford.

Such rules might bring mortgage lending to a halt if brokers fear lawsuits from buyers who claim ignorance of their own credit limits. Such a radical shift of financial responsibility could be a cure worse than the ailment.

But Congress is still weeks, if not months, from enacting such rules. The best way to save the American dream of homeownership for millions is for the industry to clean up its own act as quickly as possible. The sooner it corrects its faults, the fewer homeowners will default.