Managing the mortgage crisis

Financial institutions, regulators, consumer and industry advocates, and Congress are looking at a range of remedies to provide relief for homeowners, reform lending practices, and address broader systemic weaknesses in the home finance and structured finance industries.

Investment and banking industry advocates express concern that overzealous reforms could stifle financial innovation and make it harder for reputable borrowers who don’t qualify for prime loans to purchase homes. Few would disagree, however, that some changes are needed to enact regulation of fraudulent lending practices and more rigorously and consistently evaluate mortgage applicants’ financial readiness to borrow. Some economists, regulators, industry members, and consumer advocates are going several steps further and recommending the creation of a unified regulatory framework and federal authority to oversee mortgage lending. Currently, many lenders and brokers are regulated by the states, where the effectiveness and extent of enforcement varies.

In addition, some are advocating regulatory changes to bring greater transparency to the structured finance industry that creates CDOs and other complex debt securities and the over-the-counter (OTC) markets on which they trade.

Current initiatives

In the meantime, the government has moved forward on a few initiatives to ease the credit crunch, stimulate the economy, and stem the tide of foreclosures:

The Federal Reserve has significantly lowered interest rates to create more liquidity in the market, and bolster the economy. Lower interest rates may also renew interest in the housing market, while providing some relief for current homeowners whose ARMs are scheduled to reset.

The Fed, the FDIC, and other government agencies have proposed tougher guidelines and regulations to curb abusive lending practices.

The economic stimulus plan, approved by Congress in early 2008, temporarily raises the limits on the size of conforming loans from $417,000 to a maximum of $729,750. This move is designed to make it easier to qualify for large loans at prime rates and also relieve pressure in the market for jumbo mortgages. The plan also temporarily raises the limits on Federal Housing Administration (FHA) insured loans for homebuyers who qualify for this assistance.

In late 2007, the House passed the Mortgage Reform and Anti-Predatory Lending Act to reform consumer mortgage practices, establish licensing and registration requirements for residential mortgage lenders, and provide minimum standards for mortgage loans. In addition, the House voted to reform the Federal Housing Administration and direct up the $300 million a year into an affordable housing fund. The Senate has yet to vote on a similar bill.

In addition, the Bush administration launched a voluntary private-sector plan called the Hope Now Alliance, which is a coordinated effort to improve outreach to borrowers and reduce the numbers who enter foreclosure. Additionally, the alliance announced a plan whereby servicers may agree to defer foreclosures for 30 days to give homeowners an opportunity to renegotiate their loans. While some applaud these programs, others counter that they are too narrowly focused to provide relief for the great majority of homeowners facing foreclosure.

Congress is considering amending the bankruptcy code to enable bankruptcy judges to write down the principal value of mortgages. Currently principal residences are exempt from restructuring plans in bankruptcy proceedings. Such a move, proponents argue, would keep many people out of foreclosure and would limit investment losses. However, there is significant opposition to this approach. One of the chief arguments is that subjecting mortgages to involuntary write-down could drive up consumers’ borrowing costs for all mortgages.

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