WASHINGTON — Though it may not be the sweetheart deal they would prefer, the financial services industry is largely open to an effort by congressional Democrats to set up a government-backed refinancing program to insert a floor under falling housing prices.
At issue is an idea rolled out recently by House Financial Services Committee Chairman Barney Frank and Senate Banking Committee Chairman Chris Dodd that would let the Federal Housing Administration refinance more loans.
Under the discussion drafts of bills the lawmakers have put forth, borrowers who are underwater on their mortgages and cannot afford them would be eligible to have their principal slashed and refinanced into a long-term fixed-rate mortgage guaranteed by the FHA.
"Our initial reaction is cautiously positive because, one, it's voluntary, two, it does not involve changes to the Bankruptcy Code, and, three, it does attempt to put a floor under the housing market," said Floyd Stoner, the head lobbyist for the American Bankers Association. "What the holders of mortgages have to evaluate is: Are they better off utilizing this program or going to foreclosure? There are very real downsides for everyone involved in going to foreclosure."
Francis Creighton, a Mortgage Bankers Association lobbyist, agreed with that assessment.
"Generally speaking, what our members have been saying is that the structure seems to be something they can work with," he said. "The question is how attractive will this option be."
Under the voluntary proposal, borrowers would get a new loan worth 90% of the home's appraised market value.
Lenders then would have to trim more off the value of the mortgage they would collect from the borrower and give the difference back to the FHA as an up-front reserve against losses.
Such principal reductions could be significant, considering how far home prices have already fallen in certain areas like Miami and Las Vegas. In both regions, prices have dropped more than 19% in the last year.
The haircuts have given some in the investor community pause. At such a deep discount, investors clearly would stand to gain more from the five-year interest rate freeze plans being made through the Hope Now alliance or other loan restructurings.
Industry representatives said that servicers likely would use the Frank-Dodd plan only in instances when the return would be more profitable than a foreclosure, and that making the plan more attractive to investors could make it available to more borrowers.
"The ultimate question for the servicers is are they taking an action that is in the best interest of the pool and maximizing net present value with any loss mitigation action that they take," said Scott DeFife, a lobbyist for the Securities Industry and Financial Markets Association. "That's always the bottom line."
Joshua Rosner, a managing director at the research firm Graham Fisher & Co. Inc., said that large banking companies have been pushing for the FHA refinancing plan, because it would force investors to take a hit while giving lenders a government backstop for their riskiest loans.
"There is considerable risk for the investors. … There is a concern that they would actually have to increase their risk premiums if they know they are going to swallow losses," he said. "Institutions would cherry pick the loans so that they keep the best mortgages that have been written down and sell the riskiest to the government. Then, they are a government liability."
Despite the general industry interest in coming up with a more economically viable alternative to foreclosure, industry representatives are still trying to figure out if the plan would work. That determination would hinge partly on market projections, which vary widely.
"Your view of all this is based on what you see happening in the next 12 months," Mr. DeFife said.
"Have we hit bottom, or is the bottom yet to come? … There are differing opinions on how much worse this gets before it starts to get better, so all of your calculations on whether this is 'the thing' or not or is based on what you think is going to happen in the next four quarters."
In most cases, "People think this option provides them a better return than foreclosure," he said.
Industry representatives are looking for ways around logistical snags in the plan. Even by those who support the general concept, second liens are still viewed as a major obstacle. Though estimates vary, somewhere from 30% to more than 50% of borrowers targeted by the refinancing plan have piggyback loans. Under the Frank-Dodd plan, the subordinate liens would be extinguished, meaning that second lien holders — who typically do not hold the first mortgage — would lack an incentive to agree to any writedown.
The same problem has slowed certain modification efforts, and the conundrum has stumped the industry and Capitol Hill staff members. No clear solution has emerged, but potential scenarios include first lien holders striking a deal with those holding the second liens.
Other hiccups exist. The Frank-Dodd plan would create a mechanism to prevent borrowers from profiting from principal reductions by setting up soft second mortgages to the government for home price appreciation.
Though industry representatives recognize it is a sensitive subject, they still question why the government would receive the benefit of home price appreciation when the lender is taking the haircut.
"Lenders are, I think legitimately, asking whether they should have the opportunity to share in any home price appreciation later in the process," Mr. Creighton said.
The plan also leaves many details unclear. Both bills contain a bulk refinancing provision where servicers could offer cut-rate bids for the FHA to insure a book of loans that had significant writedowns. But many observers said the provision needs work, saying it would still require loan by loan analysis.
"This would still restore the loan-by-loan assessment of what's best for individual borrowers," Mr. DeFife said.
