Refloating the housing market

After President Obama announced his latest effort to try to stem foreclosures last week, House Speaker John A. Boehner (R-Ohio) said it was time for Washington to stop meddling and let the market bottom out. But the problem hasn’t been Washington interference; it’s been poorly designed programs and hesitant lenders. The right response to the lingering malaise in housing is to keep trying to persuade banks to take some short-term losses to minimize the long-term cost of the housing meltdown, for their own sake and their customers’.

The White House’s latest plan prods Fannie Mae, Freddie Mac and banks to refinance millions of creditworthy borrowers who can’t get new loans because they owe more than their homes are worth (so-called underwater mortgages). It also would raise the subsidies available for banks that write down the debt of defaulting borrowers, enabling deeply underwater loans to be modified, but only if it saves the lender money in the long run.

Research by the Federal Reserve shows that writing down debt is not only the most effective way to keep borrowers in their homes but also can cut a lender’s losses significantly. Nevertheless, lenders have been timid when it comes to debt reduction, fearful that borrowers who aren’t in trouble would default just to obtain a modification.

That’s why it’s important for Washington to keep tweaking these programs until lenders respond, rather than sitting back and waiting for the wave of foreclosures to subside. The administration’s proposal also dovetails with the settlement that federal and state authorities have been drafting with five major banks, which would require the banks to refinance more underwater mortgages, improve their procedures for helping borrowers who miss payments and write down more debt. If California participates — and it should — the settlement would provide more than $25 billion in relief to borrowers nationwide, as well as a new template for loan modifications that leads to far fewer borrowers re-defaulting.

Obama’s refinancing proposal would aid borrowers at the expense of Fannie, Freddie and the taxpayers who support them. But any costs would be covered by a fee on the banks that were bailed out by taxpayers. The fee would effectively spread the benefits of the bailout to homeowners who were harmed by the bubble that banks helped inflate. That seems like a small price to pay, given how much those lenders stand to gain from a healthy housing market.