Housing bailout: Helping hand or handout?

WASHINGTON -- Even as home prices jumped earlier in the decade, conservative lenders in Vermont resisted high-cost, exotic loans. Today, as a massive U.S. housing bubble bursts, the state's mortgage delinquency rate is less than 3%, while values are still stable.

In Nevada over the same period, home buyers gorged on unconventional loans, with 30% of Las Vegas borrowers taking out higher-cost subprime products in 2006. The state's delinquency rate is above 7%, home prices have plummeted, and in some areas, a majority of borrowers owe more than their homes are worth.

Should taxpayers in Vermont be asked to bail out home buyers in Nevada? The answer now taking shape in Washington appears to be, "Yes."

"That's a tough one for most people living up in Vermont to wrap their arms around," admits Ken Libby, owner of Stowe Realty in Stowe, Vt. "The majority of folks probably would say, 'Why should Congress be bailing them out?' "

With housing prices plunging in some areas, housing starts at the lowest level since 1991 and foreclosures reaching the highest level since the Great Depression, the Democratic-led Congress, with some reluctance, is crafting legislation to provide $300 billion or more in loan guarantees to help distressed borrowers refinance into lower-cost, government-insured mortgages. In return for aid, lenders would have to reduce the loan principal, and homeowners would share with the government any profit when the house is sold.

The measure, which Democrats hope to move through Congress by the end of May, is designed to stabilize the housing market and, by extension, help distressed credit markets and the overall economy. Mark Zandi, chief economist at Moody's Economy.com, who, with credit bureau Equifax, developed the state delinquency numbers, estimates 12.5 million borrowers could have no equity in their home or owe more than it's worth by early 2009. Millions will face mortgage defaults.

But while there is a growing bipartisan consensus that Washington needs to take action, there are deep divisions between lawmakers, at the White House and among the public about using tax dollars to aid individual homeowners.

Top economists at recent congressional hearings, who generally supported the emerging plan, warned lawmakers to tread carefully through myriad issues of fairness and efficiency. The overarching issue is whether intervention increases "moral hazard" — encouraging people to take undue risks in the belief they will be rescued.

On the one hand …

Then there are a host of practical issues. How do policymakers separate people who may have been hoodwinked into an unaffordable loan from those who speculated and lost? Does government policy run the risk of putting an artificial floor under home prices that are still too high, and unaffordable, in some areas? Is it fair for Congress to single out distressed borrowers who bought at the peak of the housing boom, but not help those who bought earlier?

On the flip side, how can lawmakers and the White House sit back while the little guy struggles, after the Federal Reserve last month provided a $30 billion loan for the sale of investment bank Bear Stearns to JPMorgan Chase? And do a Congress and Bush administration that actively encouraged home buying, and were late to recognize the emerging housing bubble, face a special responsibility to fix the problem?

"We must choose between messy policy options and inaction — and the cost of inaction is very high," Doug Elmendorf, a senior fellow at the Brookings Institution, told the Senate Banking Committee.

A Gallup Poll in March found 56% of the public supported government aid to borrowers; 42% opposed it. Democrats and independents were more willing than Republicans to back government intervention.

Noe Herrera, a Realtor in Las Vegas, says congressional help is justified.

"Everybody wants to blame the little guy. But … the various loans were the darlings of Wall Street," says Herrera. Not enough buyers understood the mortgage documents they were signing, Herrera says.

On the opposite side is Sharon Keeler, a homeowner in Mesa, Ariz., who works at Arizona State University in marketing. She's watched the value of her home decline, and says many people in trouble now lived beyond their means, buying homes with adjustable-rate mortgages. "Let the mortgage companies who financed them in the first place find a way to refinance them into fixed-rate mortgages," Keeler says.

Stephanie Schultz, 28, of Garfield Heights, Ohio, is a struggling homeowner. She bought her home a few years ago with no money down and an adjustable-rate mortgage that started at 5.9%. She was later diagnosed with cancer and lost her job. Though she's since found new work, she's been unable to refinance, and now faces an 11% interest rate she can't afford.

"I think (a bailout) is a good thing for working Americans who are trying to pay their bills and do the right thing," Schultz says. "I'm not asking for a handout."

The division of opinion partly reflects the fact that the housing downturn has not affected all areas equally. Home prices posted an annual decline in 77 of 150 cities tracked by the National Association of Realtors in the final quarter of 2007, but prices were up in 73 markets. California and Florida alone accounted for 30% of recent U.S. foreclosure starts, according to the Mortgage Bankers Association.

As U.S. growth slows and unemployment rises, however, Fed chief Ben Bernanke warns that the pain could spread without a more active federal response.

On April 10, the Senate, with strong bipartisan support, passed a package of tax breaks for home builders coupled with aid to homeowners and buyers. But approval came only after defeat of a proposal backed by consumer groups to let judges restructure mortgages in bankruptcy proceedings. Further, House Democrats oppose the bill as a handout to business.

House Financial Services Chairman Barney Frank, D-Mass., who, along with Senate Banking Chairman Christopher Dodd, D-Conn., is crafting the broader loan-refinancing legislation, says risk of the government losing money with his plan is modest.

While the bills provide hundreds of billions of dollars in loan guarantees, taxpayers would not face large exposure unless borrowers holding restructured loans could not meet payments. To get loans, borrowers must occupy their homes, a provision designed to weed out speculators. The bill would require that borrowers have a debt-to-income ratio of at least 35% to make sure aid flows to those who really need it.

Lenders — not the government — would bear the cost of writing down loan principal and won't be forced into the program.

Frank notes that Congress often steps in to help people buffeted by larger economic forces, through unemployment aid and other programs. The bill is "partly out of compassion … but a failure to respond makes the recession deeper." While Frank's panel estimates the bill could help 1 million to 2 million homeowners, other analysts offer smaller estimates.

One practical obstacle to large-scale refinancing is the fact that as many as one-third to one-half of subprime borrowers have second mortgages, meaning they need another lender's consent to restructure loans. Lawmakers are trying to address that issue.

James Lockhart, director of the Office of Federal Housing Enterprise Oversight said that efforts to get lenders or mortgage holders to write down loan principal have merit. But he worries that the bills could "put more and more risk on the federal government."

At a Senate Banking hearing on Wednesday, Federal Housing Administrator Brian Montgomery criticized the emerging plans, saying they would "effectively result in large subsidies for households to stay in homes that are significantly beyond their means, even at reasonably written-down levels."

"This is unfair to other households, the bulk of who made prudent decisions," Montgomery said.

Harder to borrow

But even households who made good choices aren't immune from the financial fallout of the housing and credit crisis. Local governments are seeing costs skyrocket due to constricted credit markets, even as their tax revenue plunges. College-bound students face a tougher time getting loans. Some borrowers with good credit can't get affordable mortgages because lenders have become much more selective, and some with home-equity lines of credit find them canceled.

"As much as (bail-out critics) are right in their anger because they've done the right thing, it's a little short-sighted," says Allen Sinai, president of consulting firm Decision Economics. "We don't know how much this will cascade into something bigger that will come back and bite the person who's outraged and cause a job loss."

Still, Congress is divided, with Dodd on Wednesday rejecting charges that his legislation amounted to a bailout.

Sen. Richard Shelby, R-Ala., the top Republican on the Banking Committee, raised a host of questions about the legislation, suggesting Congress take a more comprehensive, longer-view look at the causes of the downturn. "If these same families were not ready for homeownership in a booming market, it is not clear to me how they become ready in a declining market," Shelby said.

Democrats' embrace of taxpayer aid comes only after a series of voluntary efforts to address the issue. Treasury Secretary Henry Paulson last year rolled out the Hope Now initiative, to help borrowers with costly adjustable-rate subprime mortgages refinance into more affordable products. The FHA this month unveiled its own, smaller plan for loan refinancing, including reductions in mortgage principal.

The Mortgage Bankers Association says the industry assisted 869,000 homeowners in the second half of 2007. But most of the subprime borrowers who got help were merely allowed to stretch out payments. Only 150,000 got loan modifications.

While noting that many families will lose their homes even if the Frank-Dodd proposals are passed, Ellen Harnick of the Center for Responsible Lending says current voluntary efforts aren't working.

Dean Baker of the Center for Economic and Policy Research told Congress loan restructurings could help in cities such as Atlanta, Cleveland and Detroit, where home prices haven't soared to abnormal highs. They wouldn't be a good fit for pricey places such as Los Angeles, San Diego and Miami. In high-cost areas, families are likely to spend much more than necessary for housing even if their current mortgage is reduced and refinanced. A better approach might be for the government to let them stay in their homes as renters, Baker said.

Robert Sheridan of Robert Sheridan & Partners in River Forest, Ill., a residential developer, says a federal bail-out is needed because of the unprecedented nature of this housing downturn. "Price declines in housing are going to be deeper than people expected," Sheridan says. "The implications will affect the entire economy. But it needs to be done very carefully."