Leverage on the lenders

As part of his plan to spur the California economy, Gov. Arnold Schwarzenegger announced last week a belated but welcome effort to keep more troubled borrowers in their homes. Now we’d like to see the governor follow through by pushing the Legislature to turn his proposals into law and making sure that lenders deliver the relief.

For the next four years, Schwarzenegger’s initiative would require lenders to wait an additional 90 days before selling a defaulting borrower’s home. The moratorium would give lenders and borrowers more time to avert foreclosures by negotiating more-affordable mortgages. To eliminate the 90-day delay -- which would be particularly costly to mortgage servicing companies -- lenders and servicers would have to adopt temporary interest-rate cuts or other techniques that reduce monthly payments to a standard level of affordability. Modeled after the FDIC’s approach to helping troubled borrowers at the failed IndyMac Bank, the proposal encourages banks to rework loans on a mass scale without requiring big write-offs of debt.

On the plus side, the plan would provide immediate relief to borrowers while still requiring them (and lenders) to endure some pain in the long run, lessening the unfairness to borrowers who haven’t fallen behind on their payments. The governor’s bill has at least three notable shortcomings, however. There’s no enforcement mechanism to make lenders keep their pledges to modify loans. Second-mortgage holders and investors, who have resisted some efforts to modify loans, wouldn’t be pressured to accept reduced returns. And there’s no effort to pull recalcitrant borrowers into negotiations over the new terms. As odd as it may seem, one of the reasons foreclosures have continued at a breakneck pace is the inability of lenders to reach defaulting borrowers to offer them a lifeline.

Schwarzenegger also offered a bill to curb abusive lending practices, but it has less to recommend than the bill (AB 1830) that he vetoed on that subject. Like the other half of his plan, it has no credible enforcement mechanism. But two of its elements -- a requirement that subprime borrowers go over the terms of any mortgage offer with a HUD-approved loan counselor before they accept it, and a ban on mortgage brokers steering any borrower to a mortgage with worse terms than they are qualified to obtain -- provide a good starting point for the Legislature as it tries to prevent the next housing bubble.