• February’s economic stimulus package staved off a drop in consumer spending, but provided no long-term stimulus to the economy. Little has been done to relieve debt-strained homeowners with falling net worth. Standard & Poor’s/Case-Schiller 20-City index shows home prices down 16.3%, while total revolving credit – made up primarily of credit card debt – was $966 billion in June, an increase of 73% since 2003. Consumer spending in the third quarter is expected to be the weakest since the 1990-1991 recession. The unemployment rate has increased 1.3% since February and 9.4 million people are unemployed.

• The Bush administration and Congress have refused to take a comprehensive, high-impact approach to foreclosure prevention and mortgage modifications. The American Housing Rescue and Foreclosure Prevention Act of 2008 is expected to help, at most, 400,000 homeowners. HOPE Now and the Hope for Homeowners, which is scheduled to begin on October 1, at least 18 months after the housing crisis began, are narrowly drawn programs which rely exclusively on voluntary participation from mortgage lenders to encourage loan modifications, rather than a broader, system-wide approach. As FDIC Chair Sheila Bair has pointed out, voluntary modifications can not achieve sufficient scale to remedy broader community and economic harm. Furthermore, so far 67% of loan "modification" plans are simply repayment plans and don't include changing the actual terms of the original loan.

As a result, more than 2.5 million homeowners are currently facing foreclosure, which has contributed to the severe depression of home prices and has undermined confidence in the housing market. Perhaps most relevantly, these mortgage defaults rob financial institutions of liquidity and greatly devalue their mortgage backed asset portfolios. Legislation that starts with concrete steps to keep homeowners in their homes would not only shore up repayments, but signal policymakers’ commitment to the social and economic wellbeing of ordinary Americans.

• The homeowner assistance provisions in the Emergency Economic Stabilization Act were virtually non-existent. The only mortgage modification element in the legislation was a directive to the Treasury Secretary to merely “implement a plan” to encourage mortgage servicers to modify loans through HOPE for Homeowners. Even if pools of mortgage-backed securities were acquired by the Secretary, it is unclear that the Treasury would have been able to modify the loan terms. Rejected out of hand were meaningful foreclosure prevention measures such as bankruptcy protections, which are vehemently opposed by the mortgage lobby.

Proposed Action
The economic arguments for some type of recapitalization program that eases Wall Street’s credit crunch are strong. We recommend that any such program give taxpayers an equity stake in the financial institutions that are assisted. However, the nation's first priority is to repair the damage done to the housing market and to the lives of working- and middle-class Americans:

• Any proposed remedy for the financial crisis must begin with assistance for struggling homeowners. DMI believes that this should come in the form of a longer-term, government-led commitment to reshaping the mortgage landscape of this country. One promising model is the Home Owners’ Loan Corporation (HOLC). Originally established during the New Deal, HOLC made more than 1 million loans to refinance mortgages in distress, which constituted a fifth of all mortgage loans. At present, this would represent about 10 million loans, with the total value of mortgages held by HOLC in 1937 approximately equivalent to the total of all subprime mortgage loans.

Though the program has its critics, HOLC helped about 80% of homeowners who refinanced stay in their homes. Nouriel Roubini, the NYU economist who is recognized for predicting the precise dimensions of the current financial crisis years ago, advised that the “government purchase of distressed mortgages to provide debt relief to households (an HOLC-like institution)…is the most important and effective way to resolve this severe financial and economic crisis.”

• Bankruptcy protection for primary residences must be immediately put back on the table. Senator Dodd proposed this measure in April 2008 and it is regarded by most progressive housing advocates as a highly effective means of reducing mortgage defaults and foreclosures. As Martin Eakes from the Center for Responsible Lending and Self-Help Credit Union in North Carolina pointed out, there are potential limitations to the federal government rewriting mortgages: "Under the proposed bailout, most of the government's acquisitions of failing financial assets will be commercial construction loans and complex slices of home loan securities, not individual loans. The government will own pieces of loans. The other pieces are owned by investors from around the world, and all of them have rights under complex legal agreements. The government will not be able to fix the bad home loans themselves."

Giving bankruptcy judges the ability to rework the terms of primary mortgage on an individual basis would help overcome this problem and could prevent as many as 600,000 foreclosures. Furthermore, it would come at no cost to the homeowner.

• Although a moratorium on foreclosures is politically difficult to sell, DMI encourages Congress to give this serious consideration. It would provide an immediate opportunity for homeowners to work out loan modifications with lenders.

• Considering the immediate panic being expressed in the capital markets, it would be tempting to dismiss the call for re-regulation and the establishment of new consumer protections as a non-urgent issue. On the other hand, DMI believes it would be unconscionable to discuss a response to the current economic crisis without addressing regulatory oversight over financial institutions and the establishment of national anti-predatory lending provisions.

Economists have long recognized that deregulation, in the form of actions like the repeal of the Glass-Steagall Act, the unfettered ascendency of mortgage securitizations and abusive broker practices, and the federal government's encouragement of reckless underwriting practices, as leading to the subprime mortgage crisis. Congress would be derelict in its duty to not include in its rescue proposal a strong, unqualified mandate to begin a comprehensive re-regulation of the financial services industry, so that the nation's financial system is not dangerously imperiled in this way again.

Bloggers note:
This entry was written with the collaboration and research assistance of Harry Moroz.
-MWG