Relief for Borrowers

Time is running out to avoid a wider housing bailout.



IT'S MUCH easier to identify well-intentioned housing policy proposals that might make the situation worse than to craft ones that will help. An example is the Democratic plan -- stymied, for now, by the threat of a Republican filibuster in the Senate -- to let federal bankruptcy judges rewrite mortgages for distressed homeowners. If enacted, the law might spur lenders to do more of what they should already be doing: voluntary loan modifications to keep financially capable subprime borrowers out of foreclosure. But lenders would also price the risk of bankruptcy litigation into interest rates, making it harder for everyone to afford a house. Yes, it seems odd that creditors' claims to primary residences should be sacrosanct, when debtors can often protect yachts and second houses. Congress wrote the law that way, however, to keep home loan rates down.
All right, what next? A few basic principles must guide government's approach. The vast majority of today's market meltdown is attributable to business decisions that grown-ups entered into voluntarily. The people who made those decisions should have to face the painful consequences, just as they would have profited if the market had worked out differently. At the same time, as long as lenders and borrowers feel enough pain, it does not have to be the maximum possible pain. Foreclosure is the costliest outcome for all concerned. Subprime lending was marked by shoddy underwriting and the steering of underfinanced borrowers into loans they could not possibly afford. Policy should take such abuses into account.
Ideally, then, government relief would focus on a relatively narrow category of Americans: borrowers of modest means whose payment record on their current subprime loans shows that they could have handled a fixed-rate loan, perhaps backed by the Federal Housing Administration, but who now face foreclosure because of increases in their subprime "teaser" interest rates that are impossibly high. No aid should go to the many subprime borrowers who couldn't even pay their teaser rates -- or those who used subprime financing for speculative investments.
By these criteria, current proposals are relatively indiscriminate. In one way or another, most of the alternatives, such as plans being floated by the Office of Thrift Supervision, Sen. Christopher J. Dodd (D-Conn.) and Rep. Barney Frank (D-Mass.), involve the government's buying up distressed mortgages or mortgage-backed securities at a discount and then moving homeowners into lower-cost government-backed mortgages. This would cost the government tens of billions of dollars. But such ideas do promise to stem the subprime crisis quickly; their costs, though high, are at least measurable and transparent.
The public should not have to pay for even a carefully calibrated bailout except as a last resort. For now, the wisest approach is to give the Bush administration more time to push the financial services industry into modifying the loans of needy and capable borrowers. Though loan modifications have been modest so far, the program has been in operation for only a couple of months. New progress reports are due out soon. If, after a fair chance, the administration's policy fails, there may be no choice but to try it Congress's way.