White House may move to buy bad mortgages

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

The White House is considering a proposal to head off potentially millions more home foreclosures by using federal funds to buy up at-risk loans and then refinance them with more affordable terms.

Treasury Secretary Timothy Geithner and other Obama administration officials met Wednesday with a group of top bankers, community groups and financial industry representatives to discuss the plan.

So far, government efforts to prevent foreclosures have focused on pressing the lending industry to work with at-risk homeowners voluntarily and provide them with more affordable payment terms. But the new proposal signals a shift to a more direct government approach, according to John Taylor, president of the National Community Reinvestment Coalition, who attended the meeting with Geithner, Housing and Urban Development Secretary Shaun Donovan and other Obama administration officials.

“What they heard from all segments of the industry is nearly universal support for going in and purchasing these loans,” said Taylor.

The White House said Friday Obama will outline on Wednesday his plan to help struggling homeowners. Press secretary Robert Gibbs said the president will detail his ideas in a speech in Arizona. Gibbs released no other details.

The proposal is one of several being discussed as the White House completes the details of its comprehensive plan to stabilize the financial system and limit a wave of new foreclosures expected over the next few years. Others include legislation to speed up loan modifications and efforts to make new mortgages more affordable.

Under the proposal, the government would draw on $50 billion in funds already approved for the financial bailout to buy up millions of mortgages at a discount. A $300,000 mortgage on a house now worth $200,000, for example, might be bought at a 30 percent discount.

The homeowner then would be able to refinance the smaller mortgage with lower monthly payments. The government could then sell the loan back to investors, freeing money to buy more loans.

The new approach could eliminate one of the biggest roadblocks that has stymied the government efforts to buy up so-called “toxic assets” that are clogging the financial system. Trading in these securities — backed by thousands of loans — has all but shut down because banks, investors and potential buyers are unable to predict their future value. But individual loans are much easier to value, making government purchases more practical, according to the plan’s proponents.

Taylor estimates that of the roughly 10 million to 12 million households facing foreclosure over the four years, about 4 million to 5 million would be able to keep their homes. The plan would also help clear distressed mortgages from the financial system and free up more lending, said Taylor.

“These investors have suffered this loss — they just haven’t realized it yet,” he said. “It’s an unrealized loss that the government takes and then converts it into a gain for millions of homeowners.”

A spokesman for the Dept. of Housing and Urban Development confirmed that the White House is considering a plan to buy up bad loans directly. Treasury officials were unavailable for comment.

HUD Secretary Donovan met Thursday with representatives from housing and community groups to review additional ideas to try to help more homeowners keep their homes. Reuters reported Thursday that the government was considering subsidizing mortgage for homeowners who met certain criteria, but it was not clear how those subsidies would be made.

White House officials this week stressed the urgency of acting to shore up the nation’s banking system to avert a potential “catastrophe.”  But slowing the pace of foreclosures is essential to reducing the glut of homes on the market and resolving the crisis, according to Columbia University economics professor Christopher Mayer.

“We've got to deal with housing,” he said, ”because, look, if housing drops another 20 to 25 percent, I can promise you a lot more of these mortgages are going bad, and we're going to have a much bigger problem.”

Some 275,000 foreclosure filings were reported in January — or about one in 466 households — an 18 percent increase over January 2008, according to data released by RealtyTrac Thursday. The pace slowed 10 percent from December, largely because of a temporary freeze on new foreclosure filings by several states and mortgage giants Fannie Mae and Freddie Mac, RealtyTrac reported.

On Wednesday, the Office of Thrift Supervision urged lenders under its regulation to suspend foreclosures on owner-occupied homes until the White House completes its mortgage relief program. As of the third quarter of 2008, the roughly 800 lenders regulated by the office had an outstanding mortgage portfolio of more than a half-trillion dollars.

To date, industry efforts to halt the pace of foreclosures have proved inadequate. In congressional testimony Wednesday, CEOs of the nation’s top banks told of hundreds of thousands of loans modified to date.

But according to the Office of the Comptroller of the Currency, more than half of the 287,755 mortgage workouts in the third quarter of 2008 involved repayment plans that, in many cases, increased the monthly cost of the loan to make up for missed payments. That’s one reason more than half of borrowers who had worked out new mortgage terms redefault within six months, according to the OCC, which regulates nationally charted banks.

As the housing market has collapsed, roughly one in five homeowners now owe more on their mortgage than their house is worth. That’s created one of the thorniest problems in the debate over foreclosure relief: Who should bear the loss when a mortgage is bigger than a home’s value? Various proposals have been floated, including having the government share some of the loss in return for a stake in the possible appreciation of the home after it’s refinanced. 

Until recently, the hardest-hit were borrowers who were sold loans with low “teaser” interest rates that later reset to unaffordable levels. As the recession has deepened, the rapid pace of job losses has put millions more homeowners at risk.

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