What's up

The US's once rock-solid housing market starting seeing cracks in '06, but it wasn't until a Spring '07 report on home-owner defaults (WP) and a couple of mortgage-related funds going belly up over the summer that Wall Street really started to feel the housing jitters. When Bear Stearns, a bigwig investment firm with lots of action in mortgages, practically disintegrated in March '08 there was no denying the housing market woes were spilling over to the rest of the financial world.

Just how long the market will wobble along - and how much the housing crash will continue to slow down the rest of the (world) economy is unclear. What is clear is that a lot of low-income families will be losing their dream homes.

Now the president and Congress are wrestling on what - if anything - they should do prop up the market and mortgages. A couple of ideas are being batted around in the House and Senate - and may see votes this winter.

The week of March 31: The Senate may take a second shot at voting on a measure that would: add $200 million for counseling to help families refinance their homes; $4 billion to let localities buy up and rehabilitate foreclosed homes; $10 billion more in bonds to refinance collapsing mortgages; let bankruptcy judges order mortgages to be re-financed. (WP & WP)

How'd this happen?

Everyone's pointing their fingers at the sub-prime mortgage market. Sub-prime loans - which go to families with shakier credit histories - became all the rage as the mortgage market figured out how they could spread the risk of these newer mortgages by chopping up loans into parcels that they could then sell off to high risk investors (like hedge funds). See this Washington Post graphic for more on how the divvying works. The more mortgage lenders could spread their risk, the more risky loans they could make - and so they did...

source: OFHEO (pdf) Note: "MBS" is a mortgage-backed security; "Prime" mortgages are regular mortgages given to good credit customers, "Alt A" mortgages don't require as much documentation as prime mortgages do (MSNBC).

The problem was - as with many new investment products - the market got a little too excited and went out too far on the ledge. As more homeowners started defaulting, those high risk investors started pulling back - setting off a ripple of nerves that extended beyond the mortgage market.

What's keeping market watchers on edge is the fact that many high risk mortgages out there were also given at "variable rates" - that is, they start off cheap, but then - after a year or so - higher mortgage payments kick in. Many of those mortgage rate hikes will happen in the next year - and it's questionable how many homeowners are prepared for the leap.

What to do?

Economists, lawmakers and advocates of are different minds.

While some doomsdayers economists warn that the federal government should be propping up the market to avoid a larger economic downturn, many advise letting the market correct itself.

Housing advocates worry that low-income families will be hardest hit if the government doesn't step in - since they will be the first to lose out when the credit market dries up.

Lawmakers look like they want to throw out a lifeline to save some homeowners while calming the market - at the same time as regulating the mortgage market from getting too gung-ho in the future. A full-on bailout doesn't seem likely, but that depends on how ugly the credit market gets.

Expanding federal loans: Congress' first line of defense was to open up existing federal loan programs. The House passed HR 1852 the week of September 17, easing up lending criteria for federally-backed mortgages under the Federal Housing Administration, by lowering fees for high-risk buyers and bringing down down-payments to zero. The Senate passed a similar bill in December (Bloomberg).

Congress is also letting Fannie Mae and Freddie Mac, two quasi-governmental agencies that back mortgages - and that have problems of their own, expand their portfolios to cover more mortgages.

Both provisions - widening FHA's and Fannie and Freddie's portfolios - ended up being included in the economic stimulus package passed by Congress in February; Congress also decided to raise FHA's cap on mortgage prices from $362 thou to $625. In another turn-around from last year, when DC was talking about placing
tighter reins on Fannie and Freddie, their regulators have also decided
to let them keep smaller cash reserves easing up their ability to back
more mortgages. (WP & NYT).

More - radical - plans are also in the works. There's talk of setting up a new federal agency to back the mortgage securities market and of letting states do more to prop up foreclosing homes, something that was last tried during the Depression and which surprisingly has strong support from conservative and liberal think tanks.

The Treasury Department is working on a plan to save "underwater" homeowners (those who own more on their mortgage than the value of their house); it would let the FHA refinance foreclosing mortgages at the current (lower) value of a home, paying off lenders with "certificates" of their loss that they'll redeem if/when the housing market peps up again (WP & NYT & NYT & WP). Congress is working on similar plans.

Getting lenders to relax loans: The fed hatched an "alliance" with Wall Street in the fall of '07 to encourage lenders to rework loan payments on their own. Some families were able to avoid interest spikes in their "adjustable rate mortgages" while others have gotten late payment deals to avoid foreclosure - but it's unclear what percent of families in trouble are getting help. (WP, WP, NYT)

Other ways to help families refinance. Congress is also considering bills that would help families stuck in sub-prime mortgages refinance into mortgages they can manage; one HR 3778 would allow bankruptcy judges to order new mortgages. They are also considering giving out $300 million to nonprofits to better advise families on how to hold on to their homes. Another program would give states $10 billion to buy up foreclosed homes and sell or rent them to low income families.

Regulating mortgage lenders: HR 3915, which passed in November, would set new lending standards for mortgage brokers and backers, requiring - for one - that brokers make sure families can cover future payments on "adjustable rate" mortgages, as well as prevent brokers from getting "yield spread premiums" when they steer clients to packages with higher interest rates than they qualify for. It would make mortgage re-packagers (who cut up mortgages and resell them at variable risk) legally liable as well.

Tax relief: Congress figured the least it could do was not tax families on any mortgage debt they were forgiven, passing HR 3648 in late '07..

The administration, meanwhile, is making some regulatory changes as well as cutting deals with the mortgage market on its own. The Federal Reserve has proposed new regulations for mortgage lenders, but critics say they don't go far enough to protect borrowers (WP & WP). The president got lenders to agree to keep adjustable rate mortgages from ratcheting up to their higher rates (for home owners who wouldn't be able to afford the higher rate). (WP)

Resources

• HUD's quarterly housing report
• Center for Responsible Lending (an anti-predatory lending group)
• A good primer from the LATimes on how the housing market can affect the broader market.

Updated March 31, 2008