Will a Gov't. Loan Modification Plan Work?

Oct. 31, 2008 — -- Denise Harris is worried about her children. Since her divorce, it's been tough to make her mortgage payments and she's afraid that her family will soon have to move out of their Arizona home.

The children, ages 9 and 13, "don't want to move. They've gone through a divorce already and I wanted stability for our lives," Harris said, "but Mommy's got to find a creative way to make it work right now."

If the federal government offered a plan to help her modify her mortgage, Harris said, "it would mean everything."

Modifying loans is part of a new proposal now under consideration by the government, a person familiar with the matter told ABCNews.com. The proposal, by the Federal Deposit Insurance Corp., is similar to measures being implemented by the FDIC at the failed California-based bank IndyMac.

Unlike a previous government mortgage relief plan -- the Help for Homeowners plan, which Congress approved in July -- the new plan isn't dependent on a lender's willingness to write down a loan's principal. Instead, other loan modifications are favored -- namely, lowering interest rates and lengthening loan terms.

In exchange for the modifications, the government would guarantee the loans.

Some experts say that, so far, it sounds like a good idea.

"When a real big financial bubble deflates, which is what we're in the midst of here. ... Any one thing you do is not going to be enough," said Alex Pollock, the former president of the Federal Home Loan Bank of Chicago and a resident scholar at the American Enterprise Institute. "You have to try different things and this is a reasonable thing [to] try."

According to published reports, a government loan modification plan could aid 3 million homeowners, would cost up to $50 billion and could be funded by the government's new $700 billion financial rescue package.

But officials at the Treasury Department said Thursday that it was too early to discuss specific proposals.

"No specific option has been decided on. It is premature to be assigning any specific figures or parameters to these proposals," said Treasury spokeswoman Brookly McLaughlin. "The administration and Treasury and FDIC and HUD [the U.S. Department of Housing and Urban Development] have been and continue to look for ways to reduce foreclosures. And the White House has a policy process to work through the different ideas, but no decisions have been made on any particular approach."

An FDIC spokesman declined to comment, but in testimony before Congress last week, FDIC chairwoman Sheila Bair touted the benefits of loan guarantees and loan modifications.

The government, she said, "could establish standards for loan modifications and provide guarantees for loans meeting those standards. By doing so, unaffordable loans could be converted into loans that are sustainable over the long term."

She also suggested that the IndyMac program could inspire more loan modifications elsewhere.

"Our hope is that the program we announced at IndyMac Federal will serve as a catalyst to promote more loan modifications for troubled borrowers across the country," she said.

Critics have warned that loan modification plans might run afoul of contracts held between mortgage servicers and investors who hold stakes in mortgage securities, but Bair said that didn't hold true for the IndyMac plan. The contracts, she said, "typically provide servicers with sufficient flexibility to apply the IndyMac Federal loan modification approach."

Bair said that the 3,500 homeowners who had accepted IndyMac loan modification offers thus far has seen their monthly loan payments slashed by an average of more than $380.

But a new plan modeled on the FDIC's IndyMac efforts wouldn't help all struggling homeowners. Under the IndyMac plan, loans are only modified when doing so proves less costly than pursuing foreclosure.

Of the 60,000 IndyMac borrowers who were delinquent on their mortgage payments, filed for bankruptcy or in foreclosure, 40,000 qualified for loan modifications, Bair told Congress last week.

Lawrence J. White, an economics professor at New York University's Stern School of Business, said that the IndyMac plan recreates "the kind of decision that [an] old-style banker would have made."

"You don't renegotiate all loans," White said. "There are some loans you decide, the borrower isn't going to be able to repay and you foreclose. ... It's a rational decision."

Sen. Charles Schumer, D-N.Y., expressed confidence in the FDIC's work this week.

"The FDIC has had better ideas about how to solve this mortgage crisis than anyone else in the Bush administration," Schumer said in a statement released Monday night. "We hope that the White House will listen very carefully to the FDIC's proposals."

But whether the FDIC has all the support it needs to push through its proposal soon is unclear.

A source who has been following the negotiations closely told ABC News that he did not believe the announcement of a plan was imminent.

Harris, meanwhile, said she's worried that even if a plan is announced soon, it won't help her. She's afraid the government will only seek to help those who are already behind on their mortgage payments.

She's made her payments on time so far, but she's not sure how long that will last.

"I'm sliding toward there," she said. "I'm not there yet."

ABC News' Charles Herman contributed to this report.