WASHINGTON — As the House Financial Services Committee starts voting today on a bill designed to stabilize mortgage markets, even supporters concede key issues remain unsettled.
Two big questions: How many borrowers would qualify for help, and how many lenders would participate?
"There are two parts to it. There is the borrower eligibility piece, and then it's the participation by the holder. … I'm not sure what those will be," said Brian Chappelle, a partner with Potomac Partners and a former Department of Housing and Urban Development official. "Those two issues are going to be huge when determining" if the program is successful.
The plan also faces operational difficulties, including how it would treat second liens and how home market values would be established.
The bill, authored by House Financial Services Committee Chairman Barney Frank, D-Mass., would let struggling borrowers who owe more on their mortgage than the value of their home refinance into cheaper loans insured by the Federal Housing Administration. Participating lenders and investors would be required to take a significant haircut, writing the loan down to at least 15% beneath its current market value.
Determining the universe of borrowers who would qualify for such a plan has been a major issue for policymakers. Only borrowers who cannot afford their loans are eligible, and Senate Banking Committee Chairman Chris Dodd, D-Conn., who is pursuing a bill similar to Rep. Frank's, left that determination to regulators.
Rep. Frank also would give regulators some discretion, but his bill sets some parameters. For example, it would require borrowers to occupy their homes, have a mortgage debt-to-income ratio above 35%, and have a mortgage originated prior to Jan. 1, 2008.
Estimates vary widely on how many people would qualify. According to Moody's Investors Service Inc., at the end of March 8.76 million homeowners had zero or negative equity in their homes, but it is unclear how many cannot afford to make their payments.
In a note sent to House Democrats two weeks ago, Rep. Frank estimated his bill would help 1 million to 2 million borrowers. The Bush administration put the number between 500,000 and 1 million, and some private industry estimates put it at 300,000 to 500,000.
Beyond eligibility is the issue of participation: Would the lender or investor that owns the mortgage be willing to participate?
"The general feeling that we're getting from our companies is that it's a worthwhile program, but they can't guarantee how much it would be used, because it is contingent upon the investor accepting the writedown of the existing mortgage," said Paul Leonard, a lobbyist for the Financial Services Roundtable.
There is probably no way to predict the program's potential impact until it is a real choice for lenders, rather than a theoretical one, Mr. Leonard said, and market conditions at that point would be the major underlying factor.
"We can't predict how broad the use would be," he said. "It's still dependent upon conditions in the market and what the final parameters" are in the bill.
Other industry representatives said Congress should enhance incentives for lenders and investors to sign on, such as giving them a slice of the gain should a targeted home appreciate in value.
Under the legislation, to dissuade borrowers from quickly turning a profit, they would be forced to share any appreciation with the government. That sharing would be phased out over five years, at which time the borrower could sell or refinance and pay the government only an exit fee of 3%.
(Sen. Dodd's bill would split the appreciation of the home's value evenly between the government and the borrower.)
In testimony this month before the House Financial Services Committee, Gov. Randall Kroszner said sweetening the bill would have repercussions.
"Providing investors with some of the benefits of any shared-appreciation agreements might encourage them to allow servicers to write down principal and refinance borrowers into a government-backed program," he said. "However, providing the government with such agreements could be one means of compensating taxpayers for shouldering the risks associated with the program."
Laurence Platt, a lawyer for Kirkpatrick & Lockhart Preston Gates Ellis LLP, said the FHA refinancing option would be most appealing to investors looking to cash out and willing to accept hefty losses.
Servicers can target the same class of borrowers by writing down loans and tacking on the arrearage on to the back end and then collecting when borrowers sell, he said. That strategy would appeal, he said, to investors that do not want to forgive a portion of the principal debt permanently, as the Frank plan would require them to do.
"The fundamental flaw in all of these proposals is the notion that investors will unilaterally act against their self-interest for the greater community good … and that's just not likely to occur," Mr. Platt said.
As Mr. Leonard noted, another concern is how liability risk would factor into servicers' decisions to write down loans for FHA refinancings.
Reps. Michael Castle, R-Del., and Paul Kanjorski, D-Pa., backed by Rep. Frank, have tried to address that concern by offering a related bill that would protect servicers from investor lawsuits. The committee approved that bill by a voice vote on Wednesday.
Servicers have said such protection is necessary to modify loans quickly, but investors argue that such legislation would upend their legal rights by breaking contracts.
Many of the big banking companies have not taken a stance on servicer protection, mainly because they are split internally. Most operate servicing channels but invest in these loans, too.
Other sticking points remain, such as how to rectify the hang-up of second liens — a prevalent feature among the mortgages that are being targeted.
Because subordinate liens often are held by a different investor group than the holder of the primary mortgage and would need to be terminated to let the refinancing proceed.
Industry representatives said second liens continue to stymie other restructurings, and no clear solution has been nailed down.
"Communication with the second liens is still one of the biggest issues to addressing the problem," said Scott DeFife, a lobbyist for the Securities Industry and Financial Markets Association.
A representative for a large banking company said, "Everyone recognizes that it's a big problem, but no one has any idea what to do about it."
Rep. Frank's proposed solution is to set up an oversight board comprised of the heads of the Fed, the Treasury Department, and HUD and give them the task sorting it out. The board would have the flexibility to set a pricing formula for the primary lien holder to pay to subordinate lenders or to allow subordinate liens to be compensated through sharing a limited portion of the written-down loan's appreciation.
Accurately appraising properties is another big stumbling block. Under Rep. Frank's bill, lenders would hire appraisers, but they would have to be independent and certified by HUD.
But at a Senate Banking Committee hearing this month, former Treasury Secretary Larry Summers said that conducting appraisals in an illiquid market is difficult, and that if they were done incorrectly, the government would be left to bear the cost if a home's value continued to deteriorate.
"The people who are going to bear the burden if there are misappraisals are going to be the taxpayers," Mr. Summers said.
Peter Wallison, a fellow at the American Enterprise Institute, said policymakers largely have ignored the "tremendous problem" of how to assess home values.
"In a market where values are falling and nobody actually knows how far values will fall, this is a very, very difficult process," he said. "The appraiser doesn't know whether the bottom has been reached. It's another one of the technical problems … that's very easy for Congress to gloss over when they are passing legislation but which become serious obstacles to implementation."
As if those obstacles were not enough, there may be at least one more.
Steve O'Connor, the Mortgage Bankers Association's head of government relations, said the program's effectiveness in stemming the housing crisis would depend as much on market psychology as on anything else.
"There's the question of how many borrowers would be helped, and then the question of investor and homebuyer psychology," Mr. O'Connor said.
"At some point what you need to do is restore the investor and homebuyer confidence that prices aren't going to continue to drop. … So even if the number of borrowers isn't large, is it enough to kind of change the psychology? Can these rescue plans be a catalyst?"
No one knows the answer, he said. "It's too early to tell."
