Focusing on foreclosures

Three years have passed since the housing bubble burst, and yet the number of mortgage defaults and foreclosures continues to increase. RealtyTrac tallied up a record 2.8 million homes that received at least one foreclosure notice last year, and predicted that 4.5 million would go into foreclosure this year. If so, that would be nearly one out of every 20 homes. Analysts also estimate that there is a “shadow inventory” of 1.7 million to 7 million homes in foreclosure that lenders haven’t yet put up for sale.

The extremely high foreclosure rate is a problem not just for the individuals at risk of losing their homes, but also for their communities, the housing industry and the economy in general. And the problems are mounting despite the signs that fewer homeowners are falling behind on their payments, home prices may be hitting bottom and more troubled borrowers are benefiting from federal aid programs.

As of January, nearly 1 million homeowners were receiving at least temporary help through the federal Home Affordable Modification Program. But lenders are still moving too cautiously, hampered by financial complexities (such as mortgages that have been bundled and sold to investors), insufficient staff to handle the volume of modifications, uncooperative borrowers and loan servicing companies that profit from delinquent loans.

Admittedly, some borrowers took on such outlandish amounts of debt that their homes can’t, and shouldn’t, be saved. And the current loan modification programs, which are designed to help people with predictable incomes, may not be much help for homeowners who are in trouble because they have lost their jobs. Nevertheless, too few loans are being modified and too many of the modifications haven’t given borrowers a meaningful break. That’s one reason so many of the borrowers who’ve been given a second chance have defaulted again. The re-default rate drops considerably when lenders write off some of the debt, yet for the most part they’ve been either unwilling or unable to do so.

Last week, President Obama launched yet another initiative to avert foreclosures, offering $1.5 billion from the $700-billion Troubled Asset Relief Program to housing finance agencies in California and four other states where home prices have dropped by at least 20%. The administration gave states a great deal of flexibility in using the aid, which will help them craft programs for those who owe more than their homes are worth or who have lost their jobs and need temporary or transitional help.

Although the initiative is promising, there’s a drawback to the administration’s repeated efforts to lower the foreclosure rate: Lenders may be tempted to wait for Washington to give them even more incentive to modify loans, rather than offering borrowers significant reductions now. The administration should make it clear that the best deals are already on the table.

Besides, lenders’ interest in maximizing their returns should be reason enough for them to write off part of some borrowers’ debt in order to avoid a foreclosure sale that would be even costlier. The only additional motivation Congress should provide is to give bankruptcy judges the same power to write down home mortgages as they have with other types of debt. Such a change could cause lenders to raise interest rates for future borrowers, but they also would be more likely to negotiate new, mutually beneficial terms with defaulting borrowers before a judge dictates them. California lawmakers can also help by requiring lenders to determine whether delinquent borrowers qualify for a modification before they start foreclosing, not after.