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The Plans to Save Underwater Loans


After bailing out Bear Stearns, Washington may throw a lifeline to homeowners facing foreclosure

Since the start of the housing crisis, the Bush Administration has resisted using taxpayer funds to help out homeowners directly. But that resolve has weakened in the wake of the $29 billion bailout of Bear Stearns (BSC). After rushing to aid Wall Street, Washington can't very well refuse to help out struggling homeowners on Main Street. Congress is now making headway on a series of proposals aimed at bolstering the housing sector, while the White House is readying its own moves. Here's a look at what's in the works:

What are the different proposals?

Senators Christopher J. Dodd (D-Conn.) and Richard Shelby (R-Ala.) are backing a deal on a housing stimulus package that would include a $7,000 tax credit for those who buy a home in default or foreclosure, a $10 billion boost in the value of bonds that states can issue to help borrowers refinance, and tax credits for money-losing homebuilders and other businesses. In addition, momentum is growing for separate legislation that would directly aid struggling mortgage holders.

Which one will have the most impact?

Policymakers are especially concerned about the roughly 9 million homeowners who are "underwater"—meaning their houses are now worth less than the value of their mortgages. While many can afford to keep making their payments, others cannot shoulder the high interest rates but are unable to refinance because of the negative equity they now have in their homes. To help those folks out, Representative Barney Frank (D-Mass.) has proposed that the government guarantee $300 billion in new, cheaper loans. A similar bill backed by Dodd to provide $400 billion in guarantees is before the Senate. The Administration, too, is considering its own version, though analyst Jaret Seiberg of the Stanford Group expects it [the guarantee] to be smaller.

How will these measures work?

Underwater homes would be reappraised at current market values. Under Frank's plan, homeowners would be issued new mortgages for 90% of the new value of the home, and the government would get a 5% stake to compensate for the risks it is taking. The holder of the old loan—whether it is a bank or an investment pool that holds mortgage-backed securities—would be paid 85% of the home's new value.

Doesn't that mean big losses for lenders?

Absolutely. They would have to recognize losses on underwater mortgages right away. But lenders stand to lose far more in foreclosures.

What's the taxpayer cost?

That depends on the ultimate size of the program. The estimated cost of providing $300 billion in guarantees would amount to $10 billion up front. The government would recover much of that through fees and its stake in the loans. But the real risk comes if prices keep falling below the newly appraised values. Then homeowners could still default, and Uncle Sam would be on the hook for loan losses.

How many homeowners will the programs help?

No one really knows, since they all depend on how many lenders volunteer. Also, criteria for eligibility may limit the impact of these measures. Under Frank's version, only those who took out loans between January, 2005, and June, 2007, would be able to participate. A spokesman for Frank says some 1 million could be helped. But a recent study by UBS (UBS) estimates only 463,000 subprime borrowers—the hardest hit group—would benefit.

Sasseen is Washington bureau chief for BusinessWeek.

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