Foreclosure solutions won't be easy

John W. Schoen Senior producer • Profile • E-mail

With some two million homeowners facing higher monthly payments that many won’t be able to afford, conditions in the housing industry easily could get worse before they get better. A lot depends on how homeowners, lenders and investors respond as they try to head off defaults and foreclosures before they happen.

So far, the complexity of the problem has hampered effective solutions.

“I think there is a dearth of good ideas,” said Mark Zandi, chief economist at Moody’s.com. “This is a very difficult problem to tackle for policymakers. There is no magic bullet.”

One proposal — announced this week by Treasury officials after a similar plan was unveiled last month in California — would freeze interest rates on adjustable mortgages for borrowers who are currently keeping up with their payments. The hope is that by refinancing these loans, the wider damage to the housing and lending industries from bad loans and foreclosure sales can be minimized.

“There is value in these loans,” said Sheila Bair, chairwoman of the Federal Deposit Insurance Corp. “They can’t perform at the reset (rates) because those resets were never realistic. They can perform at the starter rate.”

Bair, one of the early proponents of freezing rates, said more than 80 percent of subprime adjustable-rate loans are current.

“If they’re current, that would suggest they’re viable,” she said.

Keeping those loans viable means modifying them before borrowers  fall behind. Though lenders have begun reviewing loans, the pace of refinancing has been far slower than the frenzied lending that led up to the housing bust.

“What you have right now is an industry that is under siege and doesn’t really know what to do,” said Ira Rheingold, executive director of the National Association of Consumer Advocates, which represents lawyers who work with homeowners to head off foreclosure.

One of the biggest problems is that many homeowners at risk of default qualified for loans during the easy-lending boom when underwriting standards were much more lenient. Those who got their original loan without providing proof of income will now have to do so when they ask for new loan terms. Many of them may not qualify.

Even if an underwriter can be convinced that a borrower is a good credit risk for a new fixed-rate loan, falling home prices have introduced another major wrinkle. If the loan is bigger than the value of the house securing it, investors who bought the loan will have to agree to take a loss. Without broad guidelines for those negotiations, each mortgage has to be handled one loan at a time — often with multiple investors on the other side of the transaction.

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Loan servicers — who collect payments from borrowers on behalf of investors — have some latitude to modify loans directly. But many are afraid of getting sued by investors for any losses that might result from cutting the interest rates.

“If the servicer takes too many mortgages and adjusts them, and the investor is getting punished, (the investor) is going to say, ‘Well I’m not going to give up all this. Somebody’s going to have to share this burden,”  said Michael Zoretich, vice president of CK Mortgage in Brookings, Ore.

The Treasury-backed "Hope Now" program aims to speed the process by identifying the most viable borrowers and encouraging lenders and servicers to help them arrange new loans. But some have argued that the plan doesn't go far enough. For one thing, the guidelines are voluntary.

“There’s no stick,” said Zandi. “The Treasury is trying to broker a deal. It’s not putting the Treasury on the line. It’s not saying, ‘I’ll make whole the investors. I’ll do whatever it takes to make it work.'”

One proposal making its way through Congress would give homeowners a bigger stick — by changing the bankruptcy law to allow courts to set new loan terms. (Current law bars judges from changing the terms of a primary mortgage.) The Senate Judiciary Committee is scheduled to hold hearing on the proposal Wednesday.

Proponents of the idea say the change would alter the dynamics of negotiations among borrowers, lenders and investors — even before the borrower got to bankruptcy court.

“Now the thinking changes (for the lender),” said Rheingold. "'If we do nothing, (the homeowner) may go to bankruptcy court and modify the loan in terms that are worse to us than if we just worked it ourselves.’ So it may move the ball in a direction to create the incentives necessary for the industry to do something.”

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