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Housing bailout faces tough road

Proposal would offer up to $300B in loan guarantees to stem 500,000 foreclosures

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By Janet Morrissey

May 12, 2008 6:01 am ET

A massive bailout package passed last week by the House and touted as the government's most aggressive effort to date aimed at resolving the housing crisis faces an uphill battle in getting passed into law.

Calls are being made to either adjust the proposals or water down the size of the rescue.

Financial advisers and industry experts say major changes need to be made to the bill, which was passed by the House of Representatives last Thursday, if the government hopes to stem the flood of home foreclosures and stop prices from collapsing further.

Most agree that action needs to be taken sooner rather than later, and they're hoping that threats by President Bush to veto the bill altogether can be averted.

"I could see this getting a fair amount worse if they don't do something to stem it," said Richard Drew, a certified financial planner with Hayden Financial Group in Westport, Conn., which manages about $100 million in assets.

Indeed, foreclosures are expected to surge as a large wave of hybrid and adjustable-rate mortgages are slated to reset at higher rates over the next year.

"Most of the resets on rates have not triggered yet," Mr. Drew said. "There's going to be significantly more people during the course of this year and going forward who, through resets, will see their mortgage payment increasing quite a bit."

'SPILLOVER EFFECTS'

Even Federal Reserve Board Chairman Ben Bernanke recently weighed in on the issue.

"High rates of delinquency and foreclosure can have substantial spillover effects on the housing market, the financial markets and the broader economy," he warned while speaking at the 32nd annual dinner of New York-based Columbia Business School in that city last week.

The bill encourages lenders and others to refinance troubled mortgages at about 85% of a home's current appraised value, with the rest of the mortgage being forgiven. The Federal Housing Administration would then insure up to $300 billion of these distressed mortgages — all in an effort to help at least 500,000 homeowners avoid foreclosure.

The bill is the brainchild of Rep. Barney Frank, D-Mass., chairman of the House Financial Services Committee.

A second House bill calls for a $7,500 tax credit for first-time homebuyers and $15 billion to help state and local governments buy and repair abandoned homes.

However, financial advisers and analysts say changes are needed if the proposed legislation truly is to be effective.

Nicholas Bratsafolis, chairman and chief executive of Syosset, N.Y.-based Refinance.com, said the bill "could have a dramatic impact," although much depends on how many lenders and service providers take part. Major incentives must be added to the plan to coax lenders to write down mortgages, he said.

"My company has been working with three of the major Wall Street [service providers] as well as some of the mortgage insurance companies, and I don't see that happening" without some kind of incentive, Mr. Bratsafolis said.

"People don't want to give away something for nothing," he added.

Mr. Bratsafolis suggested that a profit-sharing arrangement be added to the plan, whereby the mortgage amount is only temporarily lowered and the remainder of the mortgage is paid back when the homeowner sells or refinances the home.

Mr. Drew expressed concern that non-distressed homeowners might intentionally go into default just to take advantage of the program.

"You could invite an avalanche of people doing this," he said. "There would have to be some consequence for doing this."

Mr. Drew believes that a profit-sharing plan similar to the one suggested by Mr. Bratsafolis could discourage non-distressed homeowners from trying to tap into the program.

As a financial adviser, Mr. Drew said, he would encourage distressed homeowners to take part in the program even if it meant giving up some of the ownership profits in their home later on.

Bob Curran, a managing director at Fitch Ratings Ltd. in New York, said the proposed legislation is a "step in the right direction."

However, it isn't as clear-cut as it appears.

Mr. Curran noted that most of the mortgages have been sold and pooled into mortgage-backed securities, which are held by investors. "So it's the investors who are being encouraged to take the hit" when the mortgage principal is reduced, he said. "A [service provider] of the pool can't [lower the mortgage amount] on his own without risk of being sued. So it's kind of complicated, and I don't think all of that has been worked out yet."

Then there's taxpayer risk.

Although lowering the mortgage amount does reduce the risk of default, it doesn't eliminate it, Mr. Curran said. If home values continue to fall, the mortgage could once again be underwater and therefore in risk of default.

"There's probably still some vulnerability there in terms of further price erosion," Mr. Curran said.

Indeed, economists have projected that homes prices will likely fall another 15% on average this year.

Mr. Curran said that he'd like the bill to go further in stimulating new-home sales, possibly by offering tax credits of $15,000 to $20,000 for first-time homebuyers.

The bill has attracted bipartisan support, especially among Republicans, in areas hardest-hit by the housing crisis.

The House approved the bill by a vote of 266-154, with almost 40 Republicans giving it the thumbs up. However, the vote fell 25 votes short of the two-thirds tally needed to override a presidential veto.

The Bush administration has threatened to quash the bill. The Department of Housing and Urban Development describes it as "financially risky" and said that it "rewards irresponsible behavior."

President Bush himself told reporters that he feels that the bill would "reward speculators and lenders," and vowed to veto it.

To appease reluctant Republicans, the bill has been bundled up with other changes that have long been on the White House wish list, such as an overhaul of the Federal Housing Authority, tougher regulations for Fannie Mae in Washington and Freddie Mac in McLean, Va., and allowing state and local housing agencies to use tax-exempt bonds for refinancing distressed mortgages.

Housing proponents worry that the crisis will get far worse if a bailout doesn't come soon.

"Certainly, it would delay the housing recovery, and housing is an important part of the economy," Mr. Curran said. "There could be repercussions that affect the general economy, and Congress and the administration might want to take that into account."

E-mail Janet Morrissey at jmorrissey@investmentnews.com.

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