Economic recovery will require a comprehensive plan to resolve the housing meltdown that is the root cause of our present economic crisis. The economic stimulus program now being developed by President-elect Obama will seek to address the numerous major economic challenges our nation faces. Many of the plan’s components will benefit all homeowners. The challenges are great, and it is unclear whether there will be sufficient funding in the economic stimulus package to address some of the unique problems that face many homeowners.

There may be available funding to help homeowners in the $700 billion Troubled Asset Relief Program (TARP) approved by Congress in October. Many legislators expected that some of the first half of that amount, that it gave the go ahead to spend immediately, would be used to help the nearly 10% of homeowners who have been foreclosed or face foreclosure. Instead the Administration decided to spend $250 billion of that $350 billion to take equity stakes in banks, believing that the latter approach was essential to prevent the total collapse of the fincial services market and would be a quick and efficient way to stimulate bank lending. At the end of December the TARP was tapped to lend money to the ailing U.S. auto manufacturers, so little is left of the first half of the package.

Congressional leaders may not approve spending any of the remaining $350 billion until after President-elect Obama takes office on January 21. They are adamant that the Bush Administration make a public commitment to spending some of the remaining money to help homeowners being foreclosed or at risk of foreclosure before it will allow them to spend any of the second $350 billion. President Obama has made a commitment to help homeowners, but very serious problems remain in the financial services sector. For that reason it is likely that only a portion of the remaining $350 billion will be available for foreclosure mitigation.

There are two other serious problems in the housing sector that are a barrier to our economic recovery. The American Homeowners Grassroots Alliance believes that there’s a way to solve both, at no cost to taxpayers, and produce a large enough surplus to also help homeowners at risk of foreclosure.

One problem is that potential home buyers are remaining on the sidelines despite the drop in home prices and recent affordable low mortgage interest rates. There is a growing surplus of lender-owned homes and unsold new homes, and the housing market cannot recover until these are absorbed. Getting first time buyers back into the market is critical, because only by bringing new buyers into the market can we clear the rapidly growing inventory of lender-owned homes and revive the home building sector. In addition a home purchase by a first time buyer on average creates two more upstream purchase/sales, enabling move up purchases by homeowners currently unable to sell their homes. The main reason potential first time buyers aren’t buying is that they are reluctant to buy a home while home values continue to drop. In addition, many have trouble coming up with the substantial down payments lenders are now demanding, in part because they have seen their savings decline due to stock market turmoil. The two bright spots are that home prices have dropped to affordable levels and mortgage rates are low.

The other problem is that the 75 million American homeowners, who are the largest and most affluent segment of consumers, are cutting back dramatically on their consumer spending. It’s not just the 10% of homeowners with mortgage or other financial problems who are cutting back. The cutbacks are widespread, and caused by general fears about the economy, even among homeowners with good balance sheets and very secure jobs. Those cutbacks are a major factor in our current economic decline, and they are causing job losses throughout the entire economy.

The vast majority of American homeowners still have substantial equity in their homes and had other savings as well. Most of them have traditional fixed rate mortgages at rates of 7% or less, steady jobs, and they are not at any risk of being unable to make their mortgage payments. The problem is that these prudent homeowners have been hit with the double whammy of both substantial investment and home equity losses. They have largely stopped going to the malls and restaurants and are redirecting their income back into the savings that are essential for their retirement and their children's college education.

Until we give these homeowners the confidence to resume previous spending levels our economy cannot recover. The middle class tax cuts likely to be proposed by President elect Obama will certainly help, but they may not be enough. A federal program that could substantially reduce their mortgage interest rates could provide much more help, and could also generate a federal revenue surplus that could be dedicated to both solving the foreclosure crisis, and to creating incentives that would bring home buyers back into the market.

That 1% federal government profit on a huge number of refinancings (which could easily amount to 25 million or more) would then be directed to both reducing foreclosures and funding tax incentives for new buyers. In effect the proceeds of a program that helps credit worthy victims of the current economic crisis would help financially challenged homeowners and frightened future homeowners. The key to the success of the program is making only very safe loans so that virtually none of those loans default and most of the surplus can be devoted to addressing the other components of the housing crisis. Therefore eligibility must be limited only to homeowners with high credit ratings, financing of no more than 90% of the home’s appraised value should be allowed, and only very conservative (i.e. fixed rate) mortgages should be offered.

Part of the proceeds should be used to pay for all the transaction fees associated with refinancing mortgages to the current market value of a home, and to guaranteeing lenders against further losses should there be a subsequent failure of such restructured mortgages. Threatened homeowners who could afford payments on such a restructured mortgage would be eligible. This would save mortgage lenders the costs of foreclosing as well as the considerable marketing costs (real estate commissions, points, other settlement related fees) associated with reselling a foreclosed home. The program would be voluntary.

It is key that there be additional incentives for lenders to participate or otherwise voluntarily restructure mortgage loans so that homeowners can afford them. Lenders have supported two voluntary federal mortgage restructuring programs, Hope for Homeowners and FHASecure. Only 4,457 people have participated in these programs so far. Lenders have also voluntarily modified 2.8 million loans, typically by spreading out payment terms, and/or adding penalties and unpaid interest to the principle. The outcome has typically been that there is little or no change in the monthly payments. Nearly 37% of those modified mortgages were 60 days delinquent after six months.

There were some positive exceptions. Recent data on loan restructurings has shown that when the homeowner’s monthly payments are reduced by at least 20% through mortgage restructuring they are twice as likely to be able to keep up with their subsequent payments, compared to other homeowners who saw their monthly payments increased or only slightly reduced in a loan restructuring. This makes sense, because the major cause of the foreclosure problem is mortgage interest rate resets. Homeowners simply don’t earn enough to keep up with the higher payments, and modifying the mortgage terms is unlikely to solve the problem unless monthly payments are reduced. This approach benefits lenders as well because they are better off getting paid on regularly on a loan that is 80% of the original principle than having to foreclose and sell the home for only 60-70% of that principle. What is surprising is that so few mortgage lending executives have faced this reality and instead continue to either make minor mortgage modifications that are doomed to failure or else foreclose when a realistic mortgage restructuring would be in the best interest of their stockholders as well as the homeowner.

This irrational behavior is adverse to the best interests of stockholders of mortgage lending companies, and is compounding the foreclosure crisis. The only way to get lenders to make the substantial reductions in mortgage payments necessary to optimize the outcome for them and for homeowners is to create an environment where rational mortgage restructuring decisions will be made for them if they don’t do it themselves. For that reason, a federal law empowering bankruptcy judges to modify mortgage terms is absolutely necessary. To assuage lender concerns that such “cramdowns” would cause them to lose more than foreclosing, the law should prohibit bankruptcy judges from lowering the mortgage balance below the home’s appraised value. That law will play a major role in clearing the backlog of nonperforming mortgages and encourage more lenders to voluntarily restructure those mortgages to reduce homeowner’s mortgage balances and monthly payments. For more on this, see this month’s article entitled Support for Judicial Intervention in Foreclosures Grow.

The remaining problem is buyers who are sitting on the sidelines. They watch as home values continue to decline, and savings from the current $7,500 tax credit for first-time homebuyers, which also has prepayment provisions, could easily be outstripped by less than a year’s deflation in home values, at current rates. That tax credit expires in mid 2009, and should be replaced by a 10% home buyers tax credit, available for all purchases of primary residences through the end of next year. The new tax credit should be capped at 3.5 percent of FHA loan limits for a given market to assure that it doesn’t subsidize wealthy homeowners, and would have to be repaid only if the home were sold within three years. The revenue loss from this program would be offset by the surplus on the federal mortgage refinancing program.