FDIC Proposes Sensible Program to Avoid Foreclosures

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We support reforms to the financial marketplace that protect consumers from unscrupulous banks and lenders.

By Consumers Union on Thursday, November 20th, 2008

After all, our current economic crisis was sparked by unfair mortgage lending practices followed by a record number of foreclosures. Yet, the Administration’s rescue plan does little to keep Americans in their homes.

A new program proposed last week by the FDIC could keep 1.5 million homes out of foreclosure between now and the end of 2009, at a cost to taxpayers of $24.4 billion. Think about it – 1.5 million families that aren’t forced to move; 1.5 million houses that don’t sit empty, drawing vandalism; 1.5 million houses that don’t go on the real estate market, further depressing real estate prices for all homeowners.

The modification program would work like this:

The company to which homeowners send mortgage payments (called the “servicer”) would have to agree to participate. Participation in “voluntary” programs has been very weak so far, but this program may get better participation because it is designed to improve outcomes for all parties–the servicer, investors, and homeowners.

The loan servicer would review all its seriously past due home mortgages for owner occupied homes, and determine how much money would be lost in foreclosure for each loan. For each loan, the servicer would compare the amount the lender or investors would lose in a forecloseure to the cost to modify the loan to reduce the payment to no more than 31% of the borrower’s household income.

Homeowners would get an offer to modify the loan where the amount that the lender or investors would lose by modifying the loan is less than the probable loss in foreclosure. The FDIC estimates that this would be about half of the mortgages that are going to be in trouble by the end of 2009.

After the homeowner makes six monthly payments on the new loan, investors and the government would share any future loss on the modified loan for the first eight years of the life of the modified loan.

Everyone could benefit from this proposal: troubled homeowners, neighbors, even lenders and investors. Many families could stay in their homes. Neighbors would benefit because there would be fewer empty houses which could further depress real estate prices. The cost to lenders and investors to modify loans would be no more than they would have lost anyway in foreclosure. Investors would replace a problem loan with one that is up to one half guaranteed by the taxpayer for its first eight years.

This program would cost only about 15% of what we’ve already committed as taxpayers to buy bank stock, and less than 4% of the total of authorized bailout money.

The new program would still be voluntary for lenders, which is a key reason why Consumers Union and many other consumer and many other consumer, housing, labor and civil rights groups also support giving courts the ability to make adjustments in home mortgages in individual cases.

Some may say that some homebuyers just wanted to flip the house, but this program doesn’t cover any loans unless the owner is living in the house.

Mortgage companies sold increasingly complex loan products with payments guaranteed to double or go even higher in just two years. Many families were hit with sticker shock when the payment rose. No one — not even the sophisticated investors in the global financial markets who purchased the securities based on these loans — understood how risky these loans were.

FDIC Chairman Sheila Bair made the case in testimony before Congress this week:

The continuing trend of unnecessary foreclosures imposes costs not only on borrowers and lenders, but also on entire communities and the economy as a whole. Foreclosures may result in vacant homes that may invite crime and create an appearance of market distress, diminishing the market value of other nearby properties. Foreclosures add inventory and create distressed sale prices which place downward pressure on surrounding home values. In addition, the direct costs of foreclosure include legal fees, brokers’ fees, property management fees, and other holding costs that are avoided in workout scenarios. These costs can total between 20 and 40 percent of the market value of the property.

Here’s the FDIC’s math–the numbers of loans affected, and the costs and benefits of the proposed program.
FDIC loans affected

We have a clear choice now between spending less than 4% of the already-authorized bailout money to stop avoidable foreclosures or waiting around until those empty houses hurt our neighbors, our neighborhoods, our local tax bases, and the value of my house and your house. The proposal by the FDIC to spend just a fraction of the bailout money on this sensible new program is the smart choice.

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