Yellen, Janet
For example, several programs to mitigate the problem of foreclosures and the credit losses precipitated by falling house prices are either in effect or have been proposed. They fall into two broad categories: those aimed more or less directly at reducing the number of foreclosures by focusing mainly on helping homeowners who are at risk of losing their homes, and those designed to reduce borrowing costs for a much wider population, thereby supporting the overall demand for housing and, hence, house prices.
In the first category is the Hope Now Alliance, a voluntary program that started in October 2007 which brings together counselors, servicers, investors, and other mortgage market participants. It facilitates the reworking of mortgage loans by marshalling the incentives of lenders and borrowers to avoid the deadweight losses associated with foreclosures. A second example is Hope for Homeowners, a federal program resulting from legislation sponsored by U.S. Congressman Frank and Senator Dodd. This program went into operation at the beginning of this month. It expands the role of the FHA to improve loan “workout options” by providing a government guarantee of payment to lenders. In return, lenders must forgive a portion of the principal to make the new loan more affordable. In addition, the program includes a shared-appreciation feature in which the FHA and homeowner divide both the equity created at the beginning of the new mortgage loan and any future house-price appreciation.
Moreover, expanded versions of such workout approaches have been proposed. In particular, FDIC Chairwoman Sheila Bair has suggested guidelines to target and streamline the loan modification process. She also proposes using loan guarantees authorized by the Emergency Economic Stabilization Act as an incentive for servicers to lower mortgage payments so as to make them affordable and sustainable. 4 Other proposals are modeled on the Homeowners’ Loan Corporation instituted in the Great Depression. 5 The basic idea is that the government would offer to buy under-water loans—now about 15 percent of total mortgages—from lenders and refinance a new mortgage for qualifying homeowners at a lower rate.
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A second category of proposals is aimed at a much broader set of borrowers, and would boost the overall demand for housing by reducing borrowing costs through low-cost government loans or tax credits. 6 They hold the potential to reduce the number of foreclosures and associated credit losses both directly—by reducing after-tax house payments—and indirectly—by providing support to house prices. It is true that house prices do need to adjust, and, until they do so, potential buyers may stay out of the market. 7 However, the concern is that house prices may “overcorrect” for a number of reasons, not the least of which could be today’s extraordinarily tight credit conditions. This overcorrection could have devastating effects on the financial system and the economy, and such programs seek to avoid that outcome.