What a difference three months can make. In late July, we thought we could solve the housing crisis in a revenue-neutral way. Parts of the "Housing and Economic Recovery Act of 2008" are brilliantly constructed. However, in order to get the bill passed and signed into law, the sponsors agreed to compromises and contortions that make it almost unworkable. It is time to fix those flaws.
Let's start with the brilliant framework at the heart of the bill. Rather than bail out the lenders or the homeowners, both parties must live with some of the consequences of their mistakes. For example, the bill allows lenders to get rid of their subprime loans and put homeowners into fixed rate, FHA mortgages. However, the lenders will only receive refinancing proceeds equal to 90% of the current value of the home, which in most cases, means a significant loss. They made a bad loan and should not expect the government to save them, though 90% of current value is probably more than they would recover through the foreclosure process.
Similarly, homeowners would end up with a fixed rate mortgage, lower monthly payments and a lower principal balance. However, as part of FHA financing, families would have to give up future housing appreciation. If homeowners sell their home after a year, they would only receive 10% of the appreciation. That percentage increases by 10% each year that they live in the house, and maxes out at 50% of the appreciation after five years.
The community will also benefit from this program. Communities across this country are currently suffering from abandoned houses which undermine the safety and well being of neighboring families. If it works, the Housing Act should help to keep families in their homes.
Unfortunately, as currently enacted, the Housing Act will not help most families. The first problem is that lenders are not required to participate. In order to access this program, a distressed borrower needs to convince his or her lender to write down the existing loan. Lenders may be reluctant to take this loss, especially if the borrower is up to date with his or her payments. In addition, the loan servicers, who are responsible for the mortgages that have been securitized, open themselves up to lawsuit if they voluntarily refinance loans at a discount. I believe we should fix the Housing Act by allowing the borrower to force a refinancing. More families would apply, more people would stay in their homes and this provision would protect loan servicers from lawsuits.
The second correction needed for the Housing Act to work effectively and efficiently is to simplify the eligibility requirements. As currently enacted, borrowers must pass a large number of tests including certifications that they have "not intentionally defaulted on the mortgage or any other debt" and that their current monthly payment is greater than 31% of their income. We need to simplify the eligibility to about three criteria: 1. It is a principal residence; 2. The mortgage cannot be larger than the maximum amount for any FHA mortgage; and 3. After the refinancing the homeowner will have sufficient income under normal FHA guidelines to afford the monthly payments.
There are other flaws and complexities in the Housing Act that Congress might want to address. There are also great challenges in implementing an amended Housing Act, such as determining the value of homes in markets where there are few sales and rapidly falling prices. But if we can make two changes to the Housing Act -- give borrowers the right to force a refinancing and simplify the eligibility requirements -- we can begin to address key problems underlying the housing and financial crisis. Sheila Blair, Chairman of the Federal Deposit Insurance Corporation, argues for this kind of action when she says, "Why there's been such a political focus on making sure we're not unduly helping borrowers but then we're providing all this massive assistance at the institutional level, I don't understand it."
Markets hate uncertainty. Fixing a few flaws in the Housing Act and enabling large numbers of homeowners to access the $300 billion of FHA mortgages allocated to this program will reduce the uncertainty about the value of subprime mortgages and the securities written against those mortgages. It will also help families, lenders, servicers and neighborhoods.