What's up

The US's once rock-solid housing market starting seeing cracks last year, 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.

Just how long the market will wobble along - and how much the housing crash will 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. (As for Streeters having to hold off on buying their second yacht, fewer are bent out of shape.)

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 fall.

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 insurance market figured out how to chop up their 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.

The House passed HR 1852 the week of September 17, easing up lending criteria for federally-backed mortgages, by lowering fees for high-risk buyers and bringing down downpayments to zero. The Senate passed a similar bill in December, which will now have to be meshed with the House bill before being sent to the president (Bloomberg).

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, went ahead and started making regulatory changes and cutting deals with the mortgage market on its own. The Federal Reserve has set stricter regulations for subprime mortgages, but those rules wouldn't apply to state regulated banks; it is planning additional rules which some lawmakers say will not go far enough (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)

Some other plans that could be voted on in the fall include:

• 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

• giving out $300 million to nonprofits to better advise families on how to hold on to their homes

• let bankruptcy judges renegotiate mortgages

Resources

• HUD's quarterly housing report
• Center for Responsible Lending (an anti-predatory lending group)

Updated December 16, 2007