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Loan Modifications Could Restore Confidence

A plan for the government to partially insure lenders when they agree to modify troubled borrowers’ loan terms could help stabilize housing markets, restore confidence, and bring buyers back into the market.

Federal Deposit Insurance Corp. chairwoman Sheila Bair wants the Bush administration to provide incentives for lenders to do as many as 2.2 million loan modifications.

Under a proposal unveiled by the FDIC Friday, the government would pay servicers $1,000 for each loan modified to defray their expenses, and then agree to cover up to 50 percent of losses if a loan should re-default.

Assuming one in three modified loans were to re-default, the plan would cost taxpayers $24.4 billion, but prevent 1.5 million foreclosures by the end of next year, the FDIC said.

The plan and others intended to stem foreclosures could help stabilize housing markets, but “speed is of the essence,” said Paul Bishop, managing director of research for the National Association of Realtors.

NAR, which has its own four-point legislative plan to stimulate housing markets, has concentrated on incentives for buyers like a $7,500 tax credit for homebuyers and government-backed interest-rate buy-downs (see story).

NAR also wants Congress make credit more easily available to would-be homebuyers. One way to do that, the group says, would be to make permanent the temporary increase in the upper loan limits for Fannie Mae, Freddie Mac and FHA. The limits, boosted in February to $729,750 in high cost areas, are set to come back down to $625,500 on Jan. 1.

NAR has also been adamant that the Bush administration use at least some of the $700 billion earmarked for the Troubled Assets Repurchase Program, or TARP, the way it originally said it would: to buy up “toxic” assets like mortgage backed securities. But after earmarking the first $250 billion in TARP funds to buy shares in troubled banks, the Treasury Department now says it does not plan to buy any mortgage-backed securities.

While NAR hasn’t formally endorsed the new plan to guarantee loan modifications put forward by the FDIC, the group is generally supportive of initiatives and programs aimed at mitigating foreclosures, Bishop said.

“To the extent that the FDIC plan puts, in effect, a ceiling on the rise in foreclosures sooner rather than later, that’s all good,” Bishop said. “It’s not only how many foreclosures are prevented, but giving homebuyers in the market a sense that maybe we do have a handle on it after all. Whereas now there’s a sense that we don’t know where the end to foreclosures is.”

The FDIC’s foreclosure prevention plan and the buyers incentives and access to mortgage credit advocated by NAR are “complimentary in what they aim to accomplish,” Bishop said.

Limiting foreclosures not only slows growth in inventory and price declines, but provides reassurance to would-be homebuyers who are reluctant to buy into a downturn, Bishop said.

Once that happens, the government must also make sure that buyers who are ready to get off the fence have the financing and incentives needed to make that happen.

First-time homebuyers are key to a recovery, he said, because they are the the least encumbered.

“They don’t have a home to sell, and may be able to get out into the market more quickly than an existing homeowner,” Bishop said. “To the extent that the four-point plan we’ve put out really works to bring first time buyers into the market, that will be one of the key aspects to success for any of these plans.”

Although the Bush administration was said to be weighing Bair’s plan, last week it rolled out a less ambitious loan modification plan involving Fannie Mae, Freddie Mac and the HOPE NOW alliance of 27 loan servicers.

The administration’s plan, which FHA Commissioner Brian Montgomery said might help “hundreds of thousands of borrowers,” involves a streamlined loan modification process in which borrowers’ loan payments would be reduced to 38 percent of gross monthly income by lowering their interest rate, lengthening the term of the loan, or reducing principal and adding it to the back of the loan.

Having placed Fannie Mae and Freddie Mac in receivership, the government has a large say in how they are run. But while Fannie and Freddie own or guarantee about 58 percent of all single-family mortgages, those mortgages represent only 20 percent of serious delinquencies.

About 60 percent of seriously delinquent mortgages have been sold to investors in private-label mortgage-backed securities who may be less willing to engage in loan modifications.

The FDIC said that while foreclosures are costly to lenders, the pace of loan modifications continues to be “extremely slow.” Only 4 percent of seriously delinquent loans are modified each month, the FDIC said.

Fannie and Freddie have boosted loan modifications by 60 percent this year, but are still only averaging 4,600 a month. About 92 percent of borrowers Fannie and Freddie have worked with have been able to keep their homes.