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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?

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The aggressive plans have problems, though. Taxpayers aren't in the mood for more bailouts, and these efforts would put taxpayer dollars at risk.

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2. Push lenders to forgive principal.

It's in lenders' interest, many economists say, to write down loan balances so that fewer borrowers default. (Currently, 1 in 4 home sales involves a distressed property, and banks incur heavy costs to foreclose and sell at a loss.) The trick, they argue, is to nudge creditors to do "the right thing" for themselves as well as the economy.

The Obama administration's Home Affordable Modification Program already has some of this, in part via a "short refinance" option, in which the current lenders take a principal loss to enable an FHA refinance. But overall, the volume of loan-balance write-downs has been tepid.

One sticking point is a mismatch in incentives, says economist John Geanakoplos of Yale University in New Haven, Conn. Investors collectively "own" mortgages in bundled securities, and write-downs are arranged by loan-servicing firms with conflicting interests. His solution: Require a government trustee to determine the fate of at-risk loans, choosing foreclosure or write-downs based on the best interest of investors.

The agencies Fannie Mae and Freddie Mac also own a lot of loans, and Laurie Goodman, mortgage strategist at Amherst Securities in New York, urges legislation authorizing them to forgive more principal. Others focus on bank-held loans, arguing that regulators could prod banks to do write-downs.

The downside: Plenty of foreclosures would probably still occur, and getting new programs up and running isn't easy.

3. Do nothing more; let the market correct itself from here.

This option may not be pretty, but it's a time-honored way of working through credit problems, proponents of this approach say.

With a modest economic recovery, further declines in home prices should be modest, they predict. The downward pressure of distressed properties would be offset by an improving job market.

David Olson, a real estate consultant with Access Mortgage Research in Columbia, Md., offers another reason: Banks are swamped just trying to adapt to already-enacted housing policies and regulations (the massive financial-reform law). "They can't deal with all the change," he says. "There's a lot to be said for just letting the market adjust."

The main risk in this approach would be if the housing crisis deepens and helps push the economy back into recession. Still, current housing policies should "pretty much be enough to get us by," says Celia Chen, a housing economist at Moody's Analytics in West Chester, Pa.

The freeze in foreclosures, if it lasts, only delays the reckoning and adds to uncertainty, she says. The longer that disputes over the foreclosure process go on, "the more uncertainty there is."

In addition to delaying many foreclosure transactions currently in process, the controversy over foreclosure paperwork at some of the largest banks could potentially expand into an even bigger problem for the industry.

The team of analysts led by Ms. Goodman says the controversy could lead to broader foreclosure moratoriums (affecting more lenders), to a reexamination of the title-transfer process, or to litigation regarding homes that have already been foreclosed on and sold.