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 of '07 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 - and a few Wall Streeters will be deferring on that new yacht.

The administration and Congress are wrestling with how far they should go to prop up the real estate market and mortgages. A couple of small life-lines have passed, but a major mortgage bail-out bill, including a possible safety net for Fannie Mae and Freddie Mac, is still in the making - and could pass in July.

Congress and the fed are also taking action to prop up - and tame - the rest of the market: see Wall Street woes and economy booster for more.

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 loans by chopping them up into parcels which 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 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 excited and went out far on an untested ledge. As 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 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. Congress is working on a large-scale safety net, but it's unclear if they'll be able to pass it this year.

Expanding federal loans: Congress' first line of defense was to loosen up existing federal loan programs. As part of an economic stimulus package passed in February '08, lawmakers eased 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.

As part of the stimulus bill, Congress also let Fannie Mae and Freddie Mac, two quasi-governmental agencies that back mortgages, expand their portfolios to cover more homes. Regulators also went ahead and let the major lenders keep smaller cash reserves so they could back still more mortgages (WP & NYT). But after Fannie and Freddie's near collapse in July '08, it looks like the pressure will be on to buffer those reserves. A bill that's been long in the making (it's not news that Fannie and Freddie could get into trouble) would set new regulatory oversight. That could pass in July '08, along with measures to shore up the companies' finances.

Fannie and Freddie's overhaul will be wrapped into a larger housing rescue bill in the works. The House passed a bill in early May 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) About a third of that 500,000 will end up foreclosing on their new mortgages, ultimately costing the federal government $1.7 billion. (CBO & WP)

The Senate passed a similar bill - albeit with a smaller reach - in July. The Senate bill would also cover up to $300 billion in loans for homeowners in the lurch - but because it uses criteria different from the House bill, only about 400,000 families are likely to benefit. Also included in the Senate bill are new oversight rules for Fannie and Freddie. (WP & WP) The Senate bill also differs from the House bill by accounting for the potential cost of covering the bill by placing a 1.5% insurance premium, charging lenders and taxing Freddie and Fannie. (WP & NYT)

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 was also considering bills that would help families stuck in sub-prime mortgages refinance into mortgages they can manage - without federal backing. 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 House and Senate have okayed a number of bills to rescue neighborhoods from potential blight and breathe life into the real estate market - a number of those measures may end up in the final mega-bill working its way through Congress, although its not clear which. The Senate okayed $4 billion for states to buy up foreclosed homes and sell or rent them to low income families - as well as $14.5 billion in other tax credits (including one for new homeowners, mentioned below). From earlier reporting it seems like $6 billion of those tax breaks would go to the housing industry. (WP) The dailies were vague on whether the House did the same, merely saying
that the House bill would give $11 billion in tax help for new
homeowners and builders. (WP) There were also early signs that Congress would back up local efforts to bankroll $10 - $15 billion in refinanced homes, but the dailies stopped mentioning that effort, so cJ thinks it's been dropped. (WP & NYT)

Regulating mortgage lenders: HR 3915, which passed in November '07, 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, proposed new regulations for mortgage lenders, but critics
say they don't go far enough to protect borrowers (WP & WP & NYT) - it looks like a final set of rules is ready to go into effect October, 2009 (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 ($8,000 is the figure in an updated Senate bill); a house passed version would give new homeowners a $7500 credit (but one which they'd have to pay back). (WP) Those tax incentives are likely to be included in a mammoth housing bill that could pass in July '09. A final bill may also expand low-income housing tax credits, which encourage developers to build low income housing.

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 July 19, 2008