Though the Obama administration's foreclosure prevention plan promises to help some homeowners meet their mortgage payments, many foreclosures are still expected from borrowers who fall outside the plan or who default despite receiving financial assistance. These foreclosures will impede the real estate market's recovery, which economists agree is necessary for the economy to rebound.
Meanwhile, families should not have to agonize over relocating when the foreclosed property's early sale is unlikely. It is best for the borrower to remain in the house, because vacant properties attract vandals, deteriorate more rapidly and promote neighborhood degradation.
There is a way to stem the tide of foreclosures while generating cash for lenders to make new loans and to enhance capital.
Simply put, the government should step in and purchase from lenders, at a discount, properties underlying mortgages that are about to be foreclosed. This is a new twist on a program that worked during the Great Depression.
A government agency should be organized for the mortgage rescue. It might be named the Mortgage Recovery Corp. The MRC would agree to purchase homes securing the defaulted mortgage for 80% of the dwellings' current, fair market value. A participating lender would be required to complete the foreclosure, thereby wiping out the borrower's interest and all secondary liens, and deliver marketable title to the MRC. The borrower would not be evicted in the process.
The borrower could elect to stay in the house as a tenant. The rent paid to the MRC would be 25% of the household's gross income, even if it is nominal. That amount is a time-honored, prudent benchmark for family housing expense. The tenant would have the opportunity, but not the legal right, to repurchase the residence at its then fair market value before the government sells it to another party, provided the tenant is occupying the home and the rent is current.
Lenders should be willing participants, because they are unlikely to recover more than 80% of a mortgaged property's value net of the costs for loss of interest, maintenance, taxes, repairs and brokerage commission. Furthermore, a lender could recover as much or more from the MRC immediately instead of waging a prolonged sales effort in a severely depressed market. The up-front cash proceeds could be promptly reinvested in new loans to qualified borrowers, which would stimulate the economy. The new financing would improve a lender's earnings and capital position. Finally, the costly overhead associated with administering a portfolio of foreclosed, vacant houses in a declining market could be avoided.
While borrowers would lose their down payments and principal amortization, if any, they would avoid the disruption of relocating.
The MRC would be a variation of the Home Owners' Loan Corp. that rescued mortgage finance during the Depression. The HOLC is discussed in a recent article, "Crisis Intervention in Housing Finance — the Home Owners' Loan Corporation," published by the American Enterprise Institute and written by a resident fellow, Alex J. Pollock. Some insights into the present problem can be drawn from that article.
The HOLC was organized in 1933 "to stabilize the downward spiral in housing finance," which is identical to the MRC's purpose. The HOLC purchased mortgages for 80% of the underlying property's appraised value, which parallels the MRC's proposed acquisition cost. The HOLC recast its mortgages to provide more affordable repayment terms for borrowers. Similarly, the MRC would help borrowers stay in their homes for rents they could afford.
When the HOLC was launched in 1933, about half of all mortgages were in default. As of Dec. 5, 2008, defaulted mortgages that were ninety days past due and in foreclosure totaled 6.99% of all mortgages.
The HOLC was capitalized with $200 million and authorized to borrow 10 times its capital, or $2 billion. Adjusting those amounts to current dollars as a percentage of the GDP, the equivalent total capital and borrowings would be $514 billion. That amount could fit within an effective economic stimulus package. If the HOLC stabilized housing finance during the Depression, when almost half of the mortgages were in default, it would seem that the MRC could do the same when the default rate is 6.99% with a comparable amount of capital.
The HOLC terminated its operations in 1951 with a $14 million surplus. While that is not an attractive return on the agency's capital over 18 years, the rescue mission succeeded without an ultimate loss to the taxpayers. The MRC could reasonably expect a similar experience.
The liquidation period and final financial result should be more favorable than the HOLC experience. The MRC's sale of real estate in an upward market should result in a shorter liquidation period and a greater surplus than the HOLC's method of collecting static, long-term mortgage payments. Moreover, there are administrative and cost advantages in owning properties rather than mortgages.
Just as the HOLC came to the rescue during the Depression, the MRC could complement the Obama administration's plan to clean up the mortgage mess.