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Housing: More help may be needed

As home prices continue their dramatic fall, policymakers debate how much to intervene.

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By historical comparison, "tidal wave" is not an exaggeration. Foreclosures have reached levels not seen in past downturns since the 1930s.

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The argument for new foreclosure prevention policies rests on the idea that foreclosures are a disruptive force – pushing a flood of homes onto the market at fire-sale prices.

Big losses due to foreclosure give banks an incentive to try to prevent them – and voluntary efforts have ramped up in the past year. But, with the vast majority of troubled loans now held by pools of investors, not individual banks, it has proved hard to slow the pace of foreclosures.

Sheila Bair, who heads the Federal Deposit Insurance Corp., recently said that after about 2 million foreclosures this year, the pace won't slow down on its own. "Over the next two years, an estimated 4 to 5 million mortgage loans will enter foreclosure if nothing is done," she told Congress.

Not all foreclosures can be prevented, nor can further declines in home prices. But by preventing as many as possible, the housing market might be stabilized at higher price levels than would otherwise occur. Since falling house prices are correlated with more loan defaults, this could stop a downward spiral from feeding on itself.

Ms. Bair has crafted a plan that has won favor with Frank and other Democrats. She suggests that the government encourage lenders to write down the principal balance on troubled loans. The incentive: the government shoulders half the risk of loss if home prices fall farther and the new loan defaults.

Other loan modification plans often leave homeowners with housing costs that are 38 percent or more of their income. Bair's plan hinges on bringing down the debt to income ratio to a more affordable 31 percent.

Many housing analysts laud the effort to bring mortgage payers into a positive equity position in their homes. But it's not clear how much this program would cost (Bair says just $24 billion) or whether it would prevent the 1.5 million foreclosures that Bair estimates.

A similar plan under way since October, called Hope for Homeowners, has gotten off to a slow start, notes Mr. Hymans in Michigan.

Many critics of intervention argue that, as hard as it is on banks and individuals, foreclosures are inevitable given the excesses of the housing bubble. Many people got big loans who shouldn't have. The best way to get the housing market working again, they argue, is to give buyers and lenders the confidence that the market will operate relatively free of government manipulation.

An alternative intervention, which has been gaining steam lately, seems simpler: have the government offer everyone a low mortgage rate of 4.5 percent for a 30-year loan.

This could reduce foreclosures indirectly, by spurring buyers and stabilizing home prices. It would put needed cash in consumer pockets.

But the government runs the risk of promising low-rate loans and then seeing its own borrowing costs rise from today's historically low Treasury rates.