Fix Congress's Housing Fix

How can we get ourselves out of this mess? Renegotiation of mortgages is one way. A million were renegotiated in the second half of last year. Why? Because a more realistic mortgage is better for everyone. Lowering interest rates, extending the term of the loan, or even forgiving part of the loan will stabilize the financials and keep the borrower in the house. Often, this preserves more for the lender than would foreclosure.

This was the wisdom expressed by Jimmy Stewart, playing the community-minded savings bank manager in the Frank Capra favorite It's a Wonderful Life. But the problem now is not just a tug of wills with a miserly local bank owner called Mr. Potter. In the new world of finance, mortgages were bundled into packages—securitized is the word—and so foreclosed homes, too, have been distributed to lenders and investors all around the world, making it difficult, if not impossible, to gain their consent for partial forgiveness. Servicers that collect mortgage payments on behalf of the investors and sensibly forgive part of a loan may be liable to a lawsuit from some creditor.

Everyone is trying to find a solution for the artificial downward pressure producing unnecessary foreclosures. Three ideas are working their way through the legislative chambers of Congress. One is to eliminate the tax liability associated with debt forgiveness on owner-occupied home loans. A second is to shorten the seasoning period that rehabilitated loans need to go through before they can be sold to entities like Fannie Mae and Freddie Mac. The third idea is for government to provide backing for 85 percent of the newly appraised value of the home, if the lender is willing to accept the loss between the previous mortgage amount and the new mortgage loan.

As always, the devil is in the details. By what standards are the appraisals to be made, and who makes them, given that residential appraisals have had a very dubious record over the past five years?

Favors for fat cats. There are other grave issues. The bill before Congress again reflects how good government intentions are perverted by interest group politics. It includes an obscene package of tax cuts, a blatant Washington handout to groups with powerful lobbyists, such as home builders. It would allow home builders, banks, and other firms taking a big financial hit to apply current losses to taxes they paid in past years—a retroactive tax benefit that would partially shield them, at taxpayer expense, from the full brunt of their massive business misjudgment in the past, when they earned dramatically higher profits on these practices and kept all the profits they made at that time.

The legislation also calls for $300 billion of troubled loans to be turned over to the Federal Housing Administration, which would expand the FHA portfolio to about 1.5 million mostly high-risk subprime mortgages. The Wall Street Journal hit the nail on the head: "At the very time private lenders and investors are fleeing subprime markets, Congress wants taxpayers to dive in." The Senate bill also would double the FHA's loan limits while lowering down payment requirements on mortgage acquisitions. All in all, this would make taxpayers responsible for tens of billions of dollars of additional mortgage losses.

The Journal, hardly an enemy of business, calls the provision to allow private banks to dump risky subprime loans on the FHA "the most reckless provision now on the Senate floor," and it points out that "lenders have all but admitted that, if the bailout becomes law, they will dump their worst loans on to the FHA." No wonder homeowners who didn't live beyond their means will ask why their taxes should help out the less provident—and the most reckless lenders.

Just as bad is raising the limits on mortgages to be guaranteed by the FHA or bought by Freddie Mac and Fannie Mae. These two quasi-public corporations were set up by the government to promote homeownership for moderate- and low-income families by providing a ready pool of mortgage funds. They are now involved in approximately 70 percent of all U.S. mortgages. But under the new bill, these two agencies would be able to buy and support mortgages to a level of as much as $630,000, reflecting home values of as much as $800,000. This assistance to the relatively well-off is hardly consistent with their mission. Fannie Mae and Freddie Mac, which are privately owned, are also dragging their feet in raising enough new equity because that would dilute their share values. This is intolerable. They already benefit financially from implicit government sponsorship, for their borrowing rates reflect the credit advantages of quasi-government support. They save literally tens of billions of dollars a year from reduced interest rates—a good portion of which is passed on to the companies' private shareholders.