The U.S. government may start guaranteeing the mortgages of some homeowners who are heading for default, in hopes of persuading lenders to renegotiate the terms of troubled loans and avoid more foreclosures, Federal Deposit Insurance Corp. Chairman Sheila Bair said Thursday.
Bair told the Senate Banking Committee that the recently approved economic bailout package included authority for the Treasury Department to offer government loan guarantees and other incentives as a way to encourage banks and mortgage lenders “to prevent avoidable foreclosures.”
There has been a “failure to effectively deal with” the mortgage foreclosure problem, Bair said.
She has argued that the extensive set of financial rescue strategies deployed in recent weeks needs to do more to get at what she called the “root cause” of the crisis – the millions of households heading for default on their mortgages and potentially foreclosure on their homes.
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Her message came as more troubling news emerged Thursday about home foreclosures.
The firm RealtyTrac reported that 265,968 foreclosure notices were issued in September, a 12 percent decrease from August figures but a 21 percent increase from a year ago. The firm said one in every 475 U.S. housing units received a foreclosure filing in September. That brought the number of foreclosure filings during the third quarter to 765,558 properties, up more than 3 percent from the second quarter and up 71 percent from the third quarter of 2007.
Falling home values have been a key part of the dynamic. Some families took out loans with adjustable or low introductory rates, convinced that rising home values would let them refinance or sell before higher rates kicked in. When home values fell and credit markets froze, those same homeowners found themselves owing more on the property than it was worth, unable to refinance or cover their loan through a sale.
Bair said new efforts to stem foreclosure are needed, even if it means the Treasury offering to absorb losses on some soured mortgages.
“Loan guarantees could be used as an incentive for servicers to modify loans,” Bair said. “Specifically, the government could establish standards for loan modifications and provide guarantees for loans meeting those standards.”
Questioned by Sen. Christopher Dodd, D-Conn., the committee chairman, as to whether the FDIC has the capacity to handle such a program, Bair said the Treasury Department would be in charge, and the FDIC would act as a contractor to help guarantee loans.
One big hurdle for private mortgage companies looking to restructure loans is that no industry-wide framework has been established to guide the process.
Bair said the program would be short-term, with federal assistance ending June 30. The temporary nature of the program, she said, is the key to preventing private banks from depending on federal help for all of loans.
Neel Kashkari, the interim assistant secretary for financial stability who is heading up the government's $700 billion financial rescue effort, said the Treasury Department is still in the “policy process” of figuring out how the program would work.
“We are passionate about doing everything we can to avoid preventable foreclosures,” he said.
Kashkari said the restructured loans would be handled by the banks themselves, but with “very specific instructions.”
Although the program is first focusing on the residential housing market, there is a possibility it could be extended to the commercial real estate market as well, officials said.
Dodd emphasized a sense of urgency. “There are more than 10,000 foreclosures a day,” he said. “I hope there's a deep appreciation that we need to get this moving.”
Kashkari sought to reassure the senators that the Treasury was working as quickly as possible on all aspects of the financial crisis, saying they had made progress on implementing the $700 billion bailout. Still he said the “markets remain fragile.”
Dodd questioned him about recent reports that several major U.S. banks are leaning toward spending a portion of their federal rescue money on acquiring other financial firms rather than on issuing new loans, the primary purpose of the government's $250 billion initiative to invest in banks.
Bair said some level of acquisition activity could be a good thing. If a healthy institution acquires a struggling one, the merger could prevent larger failures and protect the federal funds being pumped in, she said.
Kashkari was asked to give a timeline for the program. Banks are now filling out applications to receive federal money, he said, and regulators have begun to give their recommendations about allocating the funds. The Treasury Department is finalizing its own review process.
He said that “$250 billion will be out the door by the end of the year.”
Dodd wasn't satisfied. “When will we have some money in the hands of the next series of banks?” he asked.
“A few weeks,” was Kashkari's answer. “It will take time for banks themselves to do their work and sign final contracts.”
He added that the hardest part about modifying loans is not the calculations – “any business school student can do that – it's getting to the homeowner. It's getting them to pick up the phone and call to find out what they can do.”