Housing Programs Are Sorry Tale of Too Much Caution

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The U.S. housing market, left mostly to its own devices for the past four years, is finally on the mend.

This is obviously a welcome development, yet it would have happened sooner if the White House hadn’t been so cautious. Its approach has relied heavily on voluntary participation by banks to modify loans. To avoid charges that it is bailing out reckless borrowers, the government has used overly strict criteria to determine which ones to help. What’s more, President Barack Obama has been too passive in letting the regulator of Fannie Mae and Freddie Mac block those companies from forgiving debt on the loans they back.

The results have been lackluster -- and have stymied the broader economy. The government’s two main programs have helped about 2.6 million homeowners, far fewer than the 9 million expected. And many of the mortgage modifications so far -- mostly reduced monthly payments -- aren’t working very well. Since 2009, about one in five borrowers helped by the Treasury’s main program has slipped back into default.

A few states have been trying to pick up the slack. Arizona, California and Nevada, all at the center of the real estate bust, are embarking on more ambitious efforts involving principal forgiveness. They will pay the full cost of erasing as much as $100,000 of mortgage debt for struggling borrowers, including those with loans backed by Fannie and Freddie.

These initiatives draw on the U.S. Treasury Department’s Hardest Hit Fund, a $7.6 billion pot of money meant for states with steep declines in home prices or high unemployment. It is financed by the 2008 Troubled Asset Relief Program. Yes, that TARP.

Pot Stirring

The state plans risk stirring the political pot in a tight election year. Yet no new money is being requested, and the federal deficit won’t rise. In essence, the states are using already appropriated taxpayer funds to help homeowners pay off large amounts of shaky mortgage debt, and allowing whoever owns the loans -- banks, investors, Fannie or Freddie -- to avoid taking losses on those mortgages.

All homeowners, not just those receiving aid, would benefit from a faster turnaround in the housing market, and this is why any political heat is worth taking. To date, the Hardest Hit Fund has been woefully underused, with just $977 million spent to assist 107,000 owners. More than 11 million U.S. borrowers owe more than their homes are worth.

The state programs could prevent additional defaults and, if home prices steadily recover, make it possible for some workers to take jobs in other states and for millions of households to feel more financially secure. Ultimately, confidence would increase and consumer spending would follow, leading to more job creation and lower unemployment.

As they should, the states are trying to avoid the moral hazard that comes with bailouts. Nevada, where 61 percent of borrowers remain underwater, is cutting loan balances by as much as $50,000 for vetted homeowners who are current on payments. Arizona and California are reducing balances by as much as $100,000 for debtors who can demonstrate financial hardship. In all three states, recipients must stay in their homes for as long as five years or else refund the state. The programs are also restricted to low- and moderate-income borrowers who can document a drop in income, loss of a job or other hardship.

Some of the criteria are too strict, blunting the programs’ effect. California, for instance, expects to use about $800 million to reduce principal for fewer than 9,000 borrowers in a state where more than 2 million have negative equity. They should loosen their income cap to help more middle-income families, too. To make enough of a dent in the number of homes with negative equity, many more states would need to adopt principal-reduction programs -- and make their initiatives similar enough that loan servicers wouldn’t balk at working with numerous state initiatives.

Bolder Program

A bolder federal program is still warranted. Treasury has spent just $5.2 billion of the almost $50 billion targeted for housing assistance. It should follow the states’ lead and spend some of the rest by assuming 100 percent of the cost of principal reductions for Fannie- and Freddie-backed loans. Treasury has already offered to pay as much as 63 cents for every $1 of principal forgiven. Throwing in the last 37 cents would only slightly increase the cost to Treasury and would save Fannie and Freddie at least $3.6 billion, their own regulator’s analysis shows.

Fannie and Freddie are working with the state programs only because the two companies are getting full compensation for principal forgiveness -- a condition of their participation. This week, Freddie issued guidance directing its servicers to cooperate with the state programs. Fannie is expected to follow suit.

The state efforts come amid a glimmer of hope in the housing market. Prices in June increased 0.5 percent from a year ago, and foreclosures in July dropped to 58,000 from 69,000 a year ago. Yet trouble spots remain. New-home sales and construction starts are still below average. Those 11 million underwater borrowers are in danger of defaulting.

The housing collapse wiped out $7.4 trillion in household values, a 55 percent decline in nominal housing wealth, according to a Bloomberg Government analysis. Housing may be coming back, but truly restoring the market will take far bolder efforts than the Obama administration has so far mustered.

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