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Foreclosed homes: three potential fixes for the crisis

Towering mortgage debt continues to fuel the housing crisis. What policies could help reduce the number of foreclosed homes?

By Staff writer / October 12, 2010

A foreclosed house in Homestead, Fla., stood locked Sept. 14. An estimated 6 million borrowers may lose homes in the next two years.

J. Pat Carter/AP

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Four years after the housing market peaked, the foreclosure crisis keeps rolling on.

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Six million borrowers could lose their foreclosed homes to the bank in the next two years, by some estimates. Other Americans are feeling the ripple effects in sagging home prices. And the problem persists despite numerous policies crafted to address it.

A new twist in this drama: Concerns raised about poor-quality legal documents have caused a sudden freeze in foreclosure proceedings by some lenders. Politicians have begun calling for all foreclosures to cease while the issue is being investigated. The upshot may be confusion and delays, but it won't end the foreclosure wave, which is driven by high unemployment and declines in home values.

Does more need to be done, and if so, what?

For the Obama administration and whoever controls Congress, that is a prime question.

Some housing experts are calling for significant new programs to help borrowers, but few see a quick or simple fix.

"I don't think the housing market is going to get any better until the labor market starts improving," says Patrick Newport, a housing economist at IHS Global Insight in Lexington, Mass. "Everything hinges on the labor market." (See story on job creation, page 32.)

In a way, America's record tide of foreclosures is just the most troubling symptom of the real problem: too much mortgage debt.

"At the top of the bubble,... we created a whole lot of debt relative to the value of houses that seemed to be there," says Alex Pollock, a finance expert at the conservative American Enterprise Institute in Washington.

Then home values fell, but much of the debt load remains on household balance sheets.

The solution involves some sort of adjustment, Mr. Pollock says, whether through default or some conversion of the debt into a new, affordable structure.

Here's a closer look at some of the main options for housing policy: an all-out approach to loan refinancing, intermediate refinancing efforts, and the status quo.

1. Create an all-out refinancing effort.

One approach, advocated by economists Glenn Hubbard and Chris Mayer, would be to offer a simple refinance for most US borrowers at today's ultralow mortgage rate (just over 4 percent). Currently, that's not available to "underwater" borrowers, whose home values have fallen lower than their loan balance (also known as negative equity). Under this approach, the low fixed rate would be available to anyone with a loan backed by Fannie Mae, Freddie Mac, or the Federal Housing Administration (FHA).

The result would put cash in the pockets of millions of borrowers – quickly and for years to come. That could boost consumer spending and reduce the likelihood of default.

One problem: Borrowers with negative equity would still be underwater. Thus they might be prone to default if they want to sell the home but can't pay off the loan.

Another approach is a refinancing program that focuses on writing down principal balances on millions of loans, forgiving enough to create positive equity. Since lenders have been reluctant to do this, a new federal effort could subsidize the lender write-downs – and perhaps recoup some of the taxpayer expense by having the government share in any price appreciation that's realized when the home is sold.

The big argument for these approaches is to try to prevent home prices from taking an additional plunge due to foreclosures. The idea is to disrupt a self-reinforcing spiral, where falling prices push more borrowers underwater, leading to more defaults, more homes for sale, more people with tarnished credit scores, and so on.

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