On the fiscal side, it is possible that Fannie Mae and Freddie Mac could play a more significant role in restoring liquidity and providing a secondary market for mortgages that reflect the lower cost of funds in many credit markets. Further exploration of the GSEs’ options for pricing and programs may result in additional support to the mortgage market.

On the monetary policy side, the Federal Reserve announced on November 25 that it would be buying up to $100 billion in GSE direct obligations, and up to $500 billion in mortgage-backed securities.[Footnote 9] A subsequent announcement on December 30 provided more details.[Footnote 10] Since the announcement of the program, designed to reduce the recently widening rate spreads on GSE debt and on GSE-guaranteed mortgages, mortgage rates have declined (see Figure 8). Some mortgages in Boston are now available for under 5 percent.

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Since stabilizing the housing market is critical, expanded use of policies that address the cost of housing finance may give further impetus for new home buyers and existing mortgage holders to take advantage of what are very low rates by historical standards.

(A) proposal developed by several Federal Reserve economists, and available on our website,[Footnote 13] suggests that the U.S. government could pay a significant portion of monthly payments for borrowers who are facing severe but temporary financial setbacks. There are two variants to the proposal. One way in which such a plan might work is for the government to offer these borrowers temporary loans that must be paid back once the borrower returns to financial health. Another version of this plan calls for the government to offer grants, not loans, to borrowers who have adverse life events, such as job loss.

Despite good-faith efforts by both the private and public sectors, the foreclosure rate remains too high, with adverse consequences for both those directly involved and for the broader economy.  More needs to be done.  In the remainder of my remarks I will discuss, without ranking, a few promising options for reducing avoidable foreclosures.  These proposals are not mutually exclusive and could be used in combination.  Each would require some commitment of public funds.

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...Beyond the steps already taken by the H4H board, the Congress might consider making the terms of H4H loans more attractive by reducing the up-front insurance premium paid by the lender, currently set in law at 3 percent of the principal value, as well as the annual premium paid by the borrower, currently set at 1-1/2 percent.  The Congress might also grant the FHA the flexibility to tailor these premiums to individual risk characteristics rather than forcing the FHA to charge the same premium to all borrowers...I n addition, consideration might be given to reducing the interest rate that borrowers would pay under the H4H program... To bring down this rate, the Treasury could exercise its authority to purchase these securities... Alternatively, the Congress could decide to subsidize the rate.

A second proposal, put forward by the FDIC, focuses on improving the affordability of monthly payments.  Under the FDIC plan, servicers would restructure delinquent mortgages using a streamlined process, modeled on the IndyMac protocol, and would aim to reduce monthly payments to 31 percent of the borrower's income.  an inducement to lenders and servicers to undertake these modifications, the government would offer to share in any losses sustained in the event of redefaults on the modified mortgages... 

A third approach would have the government share the cost when the servicer reduces the borrower's monthly payment.  For example, a servicer could initiate a modification and bear the costs of reducing the mortgage payment to 38 percent of income, after which the government could bear a portion of the incremental cost of reducing the mortgage payments beyond 38 percent, say to 31 percent, of income...Relative to the FDIC proposal, this plan would pose a greater operational burden on the government, which would be required to make payments to servicers for all modified loans, not just for loans that redefault...

A third approach would have the government share the cost when the servicer reduces the borrower's monthly payment.  For example, a servicer could initiate a modification and bear the costs of reducing the mortgage payment to 38 percent of income, after which the government could bear a portion of the incremental cost of reducing the mortgage payments beyond 38 percent, say to 31 percent, of income... Relative to the FDIC proposal, this plan would pose a greater operational burden on the government, which would be required to make payments to servicers for all modified loans, not just for loans that redefault...

Yet another promising proposal for foreclosure prevention would have the government purchase delinquent or at-risk mortgages in bulk and then refinance them into the H4H or another FHA program.  This approach could take advantage of the depressed market values of such mortgages, and buying in bulk might help avoid adverse selection problems...  Even so, this program could take some time to get up and running, and the re-underwriting required for H4H loans would likely take more time and incur greater operational costs than other plans.