The Obama administration has stepped up efforts to help homeowners refinance their mortgages, potentially bringing relief to millions of those who owe more than their homes are worth. It’s an overdue step that should boost consumer spending, even if it may not avert a huge number of foreclosures. The latter problem requires more aggressive and effective loan modifications, which banks and investors have been reluctant to do — to their own detriment.
The collapse of the housing market has left an estimated 11 million Americans owing more on their mortgages than their homes are worth. Although about 70% of those “underwater” borrowers have loans with interest rates higher than are available today, their lack of collateral has prevented them from refinancing into new, more affordable loans.
On Monday, Fannie Mae, Freddie Mac and their regulator, the Federal Housing Finance Agency, announced a more ambitious refinancing program that could enable an additional 2 million underwater borrowers who are not in default to obtain new loans. Those refinancings will reduce the returns that Fannie, Freddie and other investors stood to receive from the loans, but that’s the standard risk faced by those who buy mortgage-backed securities. More important, by cutting homeowners’ debt payments, the refinancings should improve consumer confidence and increase spending, spurring the economy.
The reduction in monthly payments should also prevent some homeowners who aren’t in default today from going into foreclosure. But it won’t provide much help for the estimated 2.2 million borrowers Moody’s Analytics expects to lose their homes in 2012. Lenders could cut their losses significantly by modifying mortgages to lower the monthly payments of defaulting borrowers, and they’ve tried a number of techniques with limited success. But they’ve balked at what analysts say would be the most effective step — writing off part of the borrower’s debt — because it has a higher upfront cost. Lenders also say there’s a moral hazard in bailing out borrowers who can’t pay off their debts.
Granted, bailed-out banks are experts when it comes to moral hazard. But it’s hard to draw clear lines of blame for the housing bubble between the enablers and the enabled, and there’s no shortage of homeowners whose property values and incomes have collapsed through no fault of their own. And it’s telling that Fannie, Freddie and most of the major national banks have refused to participate in a California program that offers to pay half the cost of principal reductions for lower- and moderate-income homeowners with a demonstrable hardship, such as a severe illness or a layoff. What moral hazard do those cases pose?
There’s some hope that state prosecutors, who are pursuing mortgage fraud claims against the major banks, will persuade them to commit billions of dollars to writing off some of the debt owed by borrowers. Those write-downs, which would occur only when they cost lenders less than foreclosing, could prove the feasability and value of principal reductions. But Fannie and Freddie, which also were rescued by Washington, need to be persuaded as well — by the administration or Congress.