Housing fixes face obstacles

Nine months into the worst housing crisis in a generation, Congress this week took up the most aggressive government plan so far to break spiraling home foreclosures and tumbling house prices that threaten to pull the economy down.

But even as a key House committee began to mark up the bill Wednesday, there were signs that the measure could be caught up in a crippling political crossfire.

Mortgage industry intransigence, voter anger over possible government aid for speculators and economists’ fear that thousands of homeowners might just walk away from troubled loans are contributing to a potential stalemate.

Election-year politics also is playing a role.

If the government fails to act -- whether with the House bill or some other equally large-scale approach -- the nation’s economic troubles could continue for several years.

The rippling effects of the housing crisis have forced families from their homes, choked credit, destroyed jobs, undermined consumer spending and inflicted huge losses on financial institutions.

“This is a recession that is significantly different from a typical recession because the single biggest cause is not the cyclical excess of supply over demand in the economy but the sub-prime crisis and its reverberations,” said Rep. Barney Frank (D-Mass.), chairman of the House Financial Services Committee and chief architect of the rescue plan.

The heart of the House plan is a proposal to require both lenders and mortgage holders to accept significant losses -- about 15 cents on the dollar -- in exchange for federal guarantees that the reduced loans would be repaid.

On that basis, the bill calls for the government to orchestrate the refinancing of hundreds of billions of dollars’ worth of troubled mortgages. Borrowers and lenders must agree voluntarily to participate in the plan.

In recent weeks, the Bush administration and the financial industry have acknowledged the need for greater government action. But now both seem emboldened to try to block the Frank bill and a similar Democratic measure starting through the Senate.

Administration officials have sought to break political momentum for the Frank plan by unveiling their own proposal, one that they say would be less costly and just as effective.

But the administration’s numbers show that its plan to expand slightly the Federal Housing Administration would help only an extra 250,000 troubled homeowners, or about the same number as now face foreclosure in a single month.

Besides the FHA proposal, the only other major administration effort has been supporting a coalition of lending industry giants called the Hope Now Alliance. The group says it has helped more than a million troubled homeowners, but, according to some participants, most of the help has consisted of rolling past-due payments into what owners owe in the future.

Meantime, financial industry officials have not rushed to embrace the House bill.

In particular, many have argued that they dare not write down loans because investors in mortgage-backed securities might sue them for slicing the value of the investors’ holdings.

To allay that concern, Frank’s committee this week approved a Republican proposal to give lenders and loan servicers protection against such lawsuits. But powerful industry groups, such as the Mortgage Bankers Assn., have scorned the proposal.

“It makes me concerned [that] lenders and servicers really aren’t interested in sitting down and negotiating a resolution to these problems,” said Rep. Michael N. Castle (R-Del.), chief author of the GOP proposal.

“Maybe they figure the government will get desperate enough at some point, it’ll throw money at the problem and they can come out with no write-down of these mortgages,” he mused.

If so, such hopes seem to be on a collision course with public opinion.

“There is no sympathy for anything that smacks of bailout,” said Allen Sinai, chief economist of Decision Economics Inc., who recently testified in favor of the Frank bill. “The outrage has shown up very quickly, and means that at this point the government can only go so far.”

Administration and industry criticism of the congressional proposals already has taken a toll.

A Senate plan to let bankruptcy judges reduce mortgage payments for those who have gone broke was withdrawn after industry outcries that it would violate the sanctity of contracts. Democrats had hoped the proposal would encourage lenders to accept voluntary cutbacks.

A key element of the Frank plan -- a system for dealing with entire portfolios of mortgages rather than one mortgage at a time -- has been nearly eliminated. The provision was cut back, at least in part, out of concern that it might let undeserving borrowers win assistance.

The pressure on Washington to act more boldly has grown, however, as the housing problem has spread and changed.

Initially, the crisis seemed confined to sub-prime mortgages made to poor people or those with sketchy credit histories. These loans typically began with low “teaser” rates that rose within a few years.

Analysts warned that resetting those rates would push monthly mortgage payments beyond the ability of many people to pay.

But the roughly 3 million adjustable-rate sub-prime loans were always a tiny fraction of the 50 million total mortgages outstanding. And nearly half of those sub-prime loans already have reset, so any problems caused by the hikes already have occurred.

In addition, the Federal Reserve’s cuts in overall interest rates have taken much of the sting out of further resets.

However, as housing prices have plummeted, new problems have arisen. Chief among them: a sharp increase in borrowers with mortgages bigger than the current value of their homes. Such underwater borrowers have a strong incentive to default.

Economy.com estimates that the number of underwater homeowners has more than tripled in the last three years and will rise to more than 12 million, or almost one in every five borrowers by next year.

Advocates of the Frank plan say the number of foreclosures has to shrink by cutting back and refinancing the most troubled mortgages. That could help home prices stabilize and eventually rise again.

But some economists worry that the plan could send the wrong signal to many others, especially those underwater.

“You could end up driving down the foreclosure rate, but driving up the delinquency rate by convincing people they’re entitled to have their losses covered,” said Karl E. Case, a real estate economist and co-designer of the Case-Shiller index, a widely cited measure of home prices.

Frank acknowledges that the situation is delicate. But he warned lenders and servicers who seem reluctant to cooperate that “we’re going to be adopting new legislation later this year, and if there’s a pattern of them not being willing to participate . . . then we’re going to pass rules that give them far fewer rights in the future.”

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peter.gosselin@latimes.com