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 fingers in mortgage pies, practically disintegrated in March '08 there was no denying 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 with how far they should go to prop up the market and mortgages. A couple of small life-lines have passed, but a major mortgage bail-out bill is still in the making - and could pass in May.

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 (temporarily) raise FHA's cap on mortgage prices from $362 thou to $625 (Congress is working on a permanent hike as well). 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 in the works. There's been 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 support from conservative and liberal think tanks.

What Congress looks like it'll end up doing is passing a bill that would back up to $300 billion in
mortgages for families in subprime and alt-A loans that are slipping into foreclosure (WP). It would be a voluntary program, with lenders agreeing to refinance the mortgage while resetting how much they're owed (syncing up with the new - lower - values of most homes). Because it's voluntary, the Congressional Budget Office (ie. hardcore accountants) think only about 500,000 of the predicted 2.8 billion homes that'll go into foreclosure procedings in the next four years will actually sign on. (WP & CBO)

The Treasury Department was working on a similar 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 & WSJ).

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) The Treasury and congressional plans mentioned in the paragraphs above would not only ease the terms of the loan, but would also deflate the value of the loan - down to the current value of the home.

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, which would let bankruptcy judges order refinanced mortgages, got dinged in the Senate. The Senate did approve, however, $150 million for nonprofits to advise families on how to hold on to their homes. (WP)

... or generally prop up the housing market. The Senate okayed $4 for states to buy up foreclosed homes and sell or rent them to low income families - as well as backing for states bankroll $10 billion in refinanced homes. The House is planning a similar measure. What the House probably won't follow the Senate on is $6 billion in tax breaks for the housing industry. (WP)

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. The administration, meanwhile, has proposed new regulations for mortgage lenders, but critics
say they don't go far enough to protect borrowers (WP & WP).

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. In '08 the Senate also okayed $1000 in tax relief for current homeowners - and $7000 for those buying foreclosed homes; the House is drafting a similar measure.

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 May 3, 2008