Will Washington fix the foreclosure crisis?

On May 8th, foreclosure prevention legislation, authored by Rep. Barney Frank (D. Mass.), was passed by the House of Representatives.  Despite significant Republican support, President Bush promises to veto.

Under the proposal, if lenders agree to accept 85% of the current appraised mortgage value, the Federal Housing Administration (FHA) will refinance the loan for the borrower. Pundits are already labeling this latest bill as a taxpayer bailout of subprime borrowers and lenders.

If FHA is only financing 85% of a home’s current value, then homeowners will have the ability and incentive to repay the FHA loan. According to Zillow.com, home values nationwide are down 9 percent from the peak of the housing market in second-quarter 2005, with some areas seeing a 30% freefall in value.

 The logic behind the legislation is that, with such a huge drop in mortgage balances and interest rates, homeowners on the verge of foreclosure will be able to afford to stay put.  With such a great incentive for homeowners to repay the FHA refinanced loan, taxpayers will not be left holding the bag (of houses).

The most obvious flaw with the Frank legislation is that it is voluntary on the part of mortgage servicer. They are being asked to accept 15% below current value, which can add up to a 40% write-off in some parts of the country. That’s a big, bitter pill.

Even if the servicer would accept such a wholesale reduction in principal, it may not even have the authority to do so since it is Wall Street investors, not the servicing company, who own these notes. This “securitization model” has been a primary barrier to voluntary loan modifications since the crash began.

The all-but-dead-for-now bankruptcy reform measure that was floated around Washington earlier this year would have given bankruptcy judges the power to reform mortgages for 100% of a home’s current value at a fair rate of interest. This is still the best solution, and the only one that leaves taxpayers out of the solution.