From Wall Street to Capitol Hill, calls are growing for the government to get into the mortgage business as the only way out of the housing crisis roiling the economy and the financial markets.
Proposals to shore up tottering home loans with taxpayer money are gaining traction in Congress and moving to the forefront of presidential politics.
Federal Reserve Chairman Ben S. Bernanke has also called on the lenders themselves to reduce the amount of principal that troubled homeowners owe on their loans.
The Fed has recently taken a series of aggressive steps to assist financial companies staggered by the credit crunch -- including providing a $30-billion short-term loan to JPMorgan Chase & Co. to facilitate its purchase of struggling Bear Stearns Cos.
Democratic contender Sen. Hillary Rodham Clinton cited that action this week in calling for a new initiative to provide $30 billion to help homeowners.
“If we can extend a $30-billion lifeline to avoid a crisis for Wall Street banks, we should extend at least $30 billion in immediate assistance to at-risk communities and families facing foreclosure,” Clinton’s campaign said in a statement.
But while the Fed can help lenders and the investment industry, it has little authority to help individual borrowers or to force their lenders to modify repayment terms so that strapped borrowers can stay in their homes. That is putting pressure on Congress to step into the breach.
“It does seem increasingly likely that we’re headed toward a compromise on taxpayer assistance to prevent a greater number of foreclosures,” said Stuart G. Hoffman, chief economist at PNC Financial Services Group.
Thus far the Bush administration has resisted anything that resembles a taxpayer- financed homeowner bailout. Instead, it has placed its faith into several programs that encourage lenders and distressed homeowners to work things out voluntarily.
And Treasury Secretary Henry M. Paulson Jr., former chief executive of investment bank Goldman, Sachs & Co., has said he believes the housing bubble should be allowed to work itself out naturally.
Critics say that’s tantamount to bailing out the big players while throwing the little guys to the wolves, and that a more evenhanded approach will make any government action more broadly palatable.
“Some say, let market discipline rule,” said Jared Bernstein, an economist at the liberal Economic Policy Institute in Washington. “But some banks are too big to fail, and some homeowners don’t deserve to lose their shirts.”
Still, a homeowner “bailout” could be a political minefield. Any relief program will have to be carefully fashioned to focus only on deserving homeowners whose financial ills are no fault of their own. Otherwise, the program could face a backlash from voters who believe they played by the rules only to have their tax money paid out to the imprudent or the crooked.
“All the talk about bailing people out is really a slap in the face of those of us who have been financially responsible,” said George Sylak, 43, a television producer from Venice who is renting his home. “Now the federal government and the candidates are saying, ‘You didn’t need to be responsible.’ ”
Others contend that what looks on the surface like a rescue of homeowners would really be a bailout of lenders who unscrupulously enticed borrowers into loans destined for trouble.
“If businesses don’t want to modify their own loans, then letting the government do it just means the government taking on the risks that the lenders don’t want,” said Marc Itzkowitz, a Palo Alto software marketing executive.
Itzkowitz says he has remained a renter because he thought that buying a home in a superheated market seemed “imprudent.”
“Not letting people meet the consequences of their actions just means that there won’t be a lesson for them, and 10 years from now we’ll be doing this again,” he said.
Many on Wall Street are impatient with the argument that offering homeowners and lenders taxpayer-financed relief will only encourage them to take similar or greater risks in the future, a concept known as “moral hazard.”
“If Washington gets off its high ‘moral hazard’ horse and moves to support housing prices, investors will return in a rush” to prudent government- and agency-backed securities, wrote Bill Gross, chief investment officer of the Newport Beach-based bond investment firm Pacific Investment Management Co., or Pimco, in a recent note to clients.
Some economists say the housing crisis is reaching such magnitude that it threatens to push the economy at large into a severe recession, a situation that would make the “moral hazard” debate seem irrelevant.
Nationally, foreclosures in February ran nearly 60% ahead of the figure a year earlier, according to Irvine-based RealtyTrac, a foreclosure-tracking service. More than 223,000 homes received loan default notices, the first step toward a foreclosure, the firm said.
That’s a grim sign for the housing market, because foreclosed properties tend to drive down prices in their neighborhoods -- which can raise the possibility of default on neighboring homes’ mortgages by reducing their owners’ equity.
“You can use legislation to address moral hazard in the future,” said Mark Thoma, a professor of economics at the University of Oregon. “If you don’t have a job you won’t be able to buy a house at all, and if you can’t get a loan because the credit markets are frozen, it won’t help you.”
One way to balance government assistance to participants in the credit crisis -- whether it’s branded a bailout or a rescue -- is to link it to tighter regulation of lenders and borrowers.
These can include strict capital requirements for investment banks that have accepted Fed money, underwriting standards for mortgages and consumer loans to prevent imprudent lending and borrowing, and mandated disclosures of the risks of various loans and bundled securities.
“There’s got to be a quid pro quo,” economist Bernstein said. “If you’re an investment bank, you shouldn’t get to shop at the Fed’s discount window without having to accept some regulation.”
Among a number of rescue plans before Congress, perhaps the one with the most political clout behind it is a proposal sponsored by Rep. Barney Frank (D-Mass.), chairman of the House Financial Services Committee, and Sen. Christopher J. Dodd (D-Conn.), chairman of the Senate Banking Committee.
The Dodd-Frank plan would grant the Federal Housing Administration expanded powers to back the refinancing of troubled mortgages -- essentially taking the loans off the original lenders’ hands -- by providing $300 billion in guarantees for new loans. Frank has scheduled a hearing on the bill for April 9.
The program would be directed at homes with values that have fallen below the balances due on their mortgages. These are the homes most likely to wind up in foreclosure.
Under the plan, the lender would be paid to surrender the mortgage -- but would get no more than 85% of the home’s appraised value. The amount would be less than the value of the original mortgage, but presumably higher than what would be received if the bank were forced to reclaim and resell the property.
The borrower would get a new loan on terms that he or she could manage. The deal would be offered only on homes that are occupied by borrowers as their primary residence, which is designed to exclude speculators and vacation homes. If the home is sold within five years, moreover, the government would get a percentage of any profit to discourage “flipping.” Frank’s committee estimates that the program could refinance as many as 2 million homes.
Everybody benefits, Frank argued in an op-ed article for the Washington Post this month, when “a prudent write-down and appropriate refinancing” take the place of a foreclosure.
Another proposal, sponsored by Sen. Richard J. Durbin (D-Ill.), would change bankruptcy law to allow mortgage terms on primary residences to be altered by bankruptcy judges in individual cases. Currently, these are the only debts that remain outside a judge’s jurisdiction.
Supporters of this plan contend that it would serve only homeowners unquestionably in distress because they would have to subject themselves to Chapter 13 bankruptcy to take advantage of its terms.
“We’ve already got a system in place to determine who should qualify for relief -- the bankruptcy system, which gives relief only to those in trouble,” said Lynn M. LoPucki, a professor at UCLA Law School. He said the Durbin bill would correct an obvious inequity in the system, which allows judges to alter repayment schedules for property speculators but not for homeowners.