Weighing Alternative Policies for Tackling the Mortgage Mess

Without government action, mortgage foreclosures will rise steeply for the next several years, mainly because declining house prices will leave many property owners with negative equity. Proposals for addressing this problem can be grouped into four categories—improving mortgage-market functioning, exhorting certain private-sector actions, forcibly reducing amounts owed, and using significant government funds. Policies enacted or suggested within the first two categories likely will have just a moderate effect on foreclosures. Policies advocated in the latter two categories could have a larger effect, but only through notable changes in the legal backdrop or government financial commitment to mortgage lending. In deciding how to proceed, policymakers should weigh the fairness of alternative approaches and effects on future mortgage credit together with the consequences of inaction for households and the overall economy.

Introduction

This note provides an overview of policies that have been put forward to address the current mortgage problems. I focus on presenting the advantages and disadvantages of different policies rather than building the case for the particular policies I favor. (Also, most of the factual assertions in this preliminary draft are not documented; appropriate references will be added later.)

The note covers the following topics in turn:

  • What is the Foreclosure Problem?
    • Three broad issues in housing and mortgage markets
    • Which households will face foreclosure?
    • Mortgage servicers and lenders will modify fewer loans than they should
    • Why should the country try to reduce upcoming foreclosures?
    • Evaluating alternative policy responses
  • Policies to Improve the Functioning of the Mortgage Market
    • Ease monetary policy
    • Relax restrictions on Fannie and Freddie
    • “Modernize” the FHA
    • Support mortgage counseling
    • Encourage shared-appreciation mortgages
    • Clarify servicers’ fiduciary responsibilities
    • Compile information on mortgage holders
  • Policies of Government Exhortations for Private-Sector Actions
    • Coordinate the “teaser freezer”
    • Expand the teaser freezer to cover more borrowers and principal writedowns
    • Encourage forbearance on foreclosures
  • Policies that Forcibly Reduce Amounts Owed
    • Change treatment of primary residences in bankruptcy
    • Block interest-rate resets
    • Block foreclosures for a specified period
    • Legislate mortgage writedowns
    • Allow current homeowners to stay as renters
  • Policies Based on Providing Government Funding
    • Change tax treatment of mortgage writedowns
    • Create a tax credit for home buyers
    • Direct money to state and local governments
    • Make loans to mortgage lenders through the Federal Home Loan Banks
    • Have a federal agency or corporation handle widespread refinancing of mortgages