Real Estate: Focusing on Foreclosures

With the election concluded, Washington can turn away from the cable pundits and turn its attention back to the financial crisis. And as they do, one task looms large: What's the best way to help struggling homeowners who are facing foreclosure?

It's an effort that began more than a year ago, when the government began offering programs like FHA Secure and the Hope Now alliance. Those programs are intended to help homeowners refinance into more affordable mortgages or work with lenders to modify their loan terms and reduce their payments. But as unemployment increases and more people face the prospect of foreclosure, critics say these initial programs aren't doing enough to help. With taxpayers putting up hundreds of billions of dollars to bail out financial institutions, it's time for the government to become more proactive about saving people's homes.

While there is no shortage of proposals for what should be done, by far the leading contender is being pushed by Sheila Bair, the chairman of the Federal Deposit Insurance Corporation (FDIC). This summer, the FDIC took over a failing bank called IndyMac and went to work swiftly modifying thousands of homeowners loans. Instead of doing a painstaking case-by-case analysis of each loan, which is what made existing modification programs move so glacially, IndyMac began applying standard formulas, based on each homeowner's income to determine whether they could reduce the interest rate or extend the term of the loan to create an affordable monthly payment.

Under the FDIC's plan, this type of program would become a nationwide standard. But for the last week the proposal has been bogged down by bureaucratic snafus. On Tuesday, The Wall Street Journal reported that officials at the Treasury Department and the White House weren't yet willing to sign-on. Some observers believe the Republican administration wanted to sit on the proposal until after the election, to avoid giving the appearance that it was totally ignoring John McCain's proposal to have the federal government buy up mortgages from troubled homeowners.

Does the FDIC plan make sense? To get an answer, I called Bruce Marks, CEO of the nonprofit Neighborhood Assistance Corporation of America. Marks, whom the Boston Globe once called "one of the most feared men in the corporate boardrooms of the nation's leading financial institutions," has spent years advocating for homeowners. In the last year, his group has helped thousands of U.S. homeowners work with banks to modify their mortgages. His take on the FDIC plan: "It's a huge step forward ... Sheila Bair gets it."

As Marks sees it, there are fatal flaws with the existing government programs to help refinance or modify loans. For many homeowners, refinancing is out of the question, since their homes are now worth less than their loan amount, and their credit scores have fallen due to missed mortgage payments. Marks says too many loan modifications don't take a realistic look at whether the homeowner will really be able to make the new payment.

In contrast, the FDIC program starts by taking a hard look at what homeowners can actually pay. Once it calculates an affordable payment, pros start playing with the mortgage numbers to see what they can adjust to hit that magic number. They start by reducing the interest rate. If that doesn't push the payment low enough, they'll extend the term of the loan. As a last resort, they'll consider lowering the principal amount of the mortgage. The mortgage holder loses money in any of these scenarios, but the appeal of these deals is that they usually lose less than if they foreclose on the house. Marks says these deals are also better in the long run than modifying a mortgage that winds up in default a few months later.

"If you provide a homeowner with an affordable mortgage payment that you lock-in forever, there's a fully amortizing loan," he says, meaning the homeowner will be gaining equity with each payment and will eventually pay the loan down to zero. Even if the homeowner is currently "underwater" (meaning the loan exceeds the value of the home), if they can afford the payment and are building equity, they have every reason to stay in the house.

Marks' views make sense to me. At root, the mortgage crisis was sparked when the industry's underwriting process lost its focus on the question that should be its primary interest: Can this person pay back this money? Now, as the government seeks to help thousands of homeowners out of this crisis, creating a streamlined program that's focused on that question sounds like a smart move.