Haas Research Intelligence
A Solution to the Mortgage Crisis
By Kenneth Rosen, Chairman of the Fisher Center for Real Estate and Urban Economics, University of California at Berkeley
Americans face a financial crisis the likes of which we have not seen since the stock market crash of 1929. The mortgage and housing markets are spiraling downward. Banks and other financial companies continue to face accelerating write-downs of their mortgage portfolios. If this downward spiral continues, the destruction will sweep through the U.S. and international economies, wreaking havoc from Wall Street to Silicon Valley, from London and Paris to Singapore and Bangalore.
Congress must step in and create a sweeping loan modification program to solve the underlying problem: a foreclosure crisis created by the ill-conceived mortgages that flooded the market during the last four years. The recipients of these mortgages, mostly working class Americans, cannot make payments that are increasing 20% to 30% in one year. Consequently, a record number of homeowners in California are now facing foreclosures. And the meltdown is nowhere near over because even more homeowners will face such skyrocketing payments within the next one to two years.
Lower interest rates – the Federal Reserve Board's solution – will not solve the problem. The only way to stop the downward spiral is a massive loan modification and restructuring program for consumers. While the Secretary of the Treasury and the Federal Reserve Board have urged home mortgage lenders to undertake such a program, they are doing so on only a very limited basis. The problem is there is no force of law behind the plan and conflicting interests among mortgage investors.
If we fail to do more, the cascade effects of this foreclosure crisis will continue to worsen. A further trillion dollars in home mortgages will go bad, triggering even more chaos in financial markets.
Congress should step in with legislation – an Emergency Home Refinancing and Restructuring Act – that creates a mandatory mortgage restructuring program. The first step would be to impose a 180-day moratorium on foreclosures and mortgage payment resets for owner-occupied houses. This will stop the process and provide the time to create a national mortgage refinance and restructuring program. Second, Congress should appoint a Mortgage Refinance Board that includes the Secretary of Treasury, the Chairman of Fed, and a newly appointed mortgage czar. The board's charge: to propose mandatory guidelines to facilitate the mortgage refinance process and override current mortgage pool contracts. The goal would be to enable homeowners who can afford to pay their original mortgage payments to stay in their homes and avoid foreclosure.
A public/private working group should be set up immediately to draw up several refinancing alternatives. A few key guidelines should be followed. Mortgage payments should not be allowed to increase by more than 7.5% a year, and mortgage interest rates on subprime loans should be reset no more than 1 percentage point higher than the current prime mortgage rate. If a homeowner's mortgage is higher than the value of his or her home, the difference should be forgiven and the loss passed on to the investor who owns the loan. Moreover, all prepayment and late charges on mortgages should be forgiven. Finally, government-sponsored agencies such as Fannie Mae, Freddie Mac, and the Federal Housing Administration should be allowed to buy these loans. These guidelines would prevent 75% of foreclosures and more financial chaos.
The only way to stop the downward spiral is to stop it at its source: the homeowner. It is not only unreasonable to expect households to make the massive payment increases required by these ill-designed mortgages; it is a recipe for disaster for our whole economy. All of the investors involved in the disaster must work together to develop a mandatory mortgage refinancing plan to minimize risk and share losses. We need to help people stay in their homes.
(December 3, 2007)
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