Foreclosures: Feds to the Rescue?

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"Winners and Losers"

Exactly how that would work isn't clear. The government could guarantee a loan that pays off part of the principal, thus lowering the payment. Or it could guarantee a loan that replaces the original mortgage—a prospect that could raise thorny legal issues (BusinessWeek, 10/15/08) because of the way mortgages have been sliced and diced into securities.

Other key details also have not been disclosed. It's not known to what levels borrowers will be able to reduce their mortgages. It's also unclear who would be eligible for the loans. Eligibility could be based on such factors as how big the mortgage is relative to the homeowner's income or how up-to-date their mortgage payments are. "Drawing that line will create winners and losers and create political issues," says the lobbyist.

The lobbyist said the program would only cover five years, because a permanent reduction would require too much of a sacrifice from the lenders. "That's too much of a loss for the industry," he said.

Doubts About Plan's Effectiveness

Some analysts say such a program based on government guarantees ultimately won't work. For one thing, it would fail to fix the underlying problem: borrowers' inability to pay. Many homeowners are in trouble because they've lost their jobs or will be losing them as the recession picks up steam. For them, paying off a mortgage even at lower rates may be impossible.

The proposal's success could hinge on unrealistic expectations of an economic recovery, wage increases, and a recovery in home prices. After five years, homeowners may need to refinance or sell their homes at a higher price.

"Buying a lot of mortgage insurance—isn't that how we got into this mess?" says Peter Morici, a professor at the University of Maryland's Robert H. Smith School of Business. "Something must be done [to stem foreclosures], but the government will have to appropriate real money." Morici says the government would have to spend hundreds of billions of dollars to prevent large-scale foreclosures.

But others expressed relief that a mandatory program may be forthcoming at the federal level.

"We are heartened that it seems more elected officials and regulators realize that more has to be done for homeowners," says Kathleen Day, a spokesperson for the Center for Responsible Lending, an advocacy group for borrowers. "To actually get to the root cause of financial turmoil you have to keep more people in their homes."

Keith Gumbinger, vice-president of the mortgage consulting firm HSH Associates in Pompton Plains, N.J., says he's encouraged by the FDIC's announcement. "It sounds like the FDIC has learned a few things about servicing and financing with its experience with IndyMac," says Gumbinger, referring to IndyMac Federal Bank (IDMCQ.PK), which was seized by the feds in July and has been undergoing a fast-track loan modification program (BusinessWeek, 10/8/08).

But a mortgage plan can only be assessed once it's revealed in its entirety, Gumbinger says. "The devil's in the details."

With Theo Francis and Jane Sasseen.
Herbst is a reporter for BusinessWeek.com in New York.