U.S. moves could ease housing crisis, not end it

The federal government can't lift the housing market out of a hole, but it might be able to provide some helpful ladders.

That's increasingly the view of politicians and economists alike, even some conservatives who don't typically hanker for Washington rescue plans.

The reason: They see a housing crisis that seems to be growing in magnitude – replete with foreclosures, bank losses, and declining household wealth. It threatens to constrict normal economic growth and the flow of credit.

"I think people have walked to edge of the cliff and looked down and said, 'This doesn't look good,' " says Brian Bethune, an economist at Global Insight, a forecasting firm in Lexington, Mass.

The challenge for Washington is to walk a fine line. Veer too far toward bailouts, critics say, and the result will simply be to waste taxpayer money and postpone the housing-market correction that would restore a balance of supply and demand. But policies to reduce the number of foreclosures and slow their pace, advocates say, might help all Americans by giving the banking system breathing room to work through its losses.

"If you had a series of complementary or consistent steps, then all of those things working together would get us over the hump," Mr. Bethune says.

Here are some of the main options:

• Fund the helpers. Across the country, neighborhood groups approved by the federal Department of Housing and Urban Development offer counseling to at-risk homeowners. President Bush and many in Congress want to expand funding for them.

•Offer fast relief. One big idea is to encourage mortgage firms to freeze the interest rates of large groups of borrowers who might face foreclosure when their adjustable mortgage rates reset higher. This voluntary plan is already in the works, announced last week by President Bush.

Critics call it government meddling in the marketplace, since lenders are free to modify loans on their own if it makes sense. Treasury Secretary Henry Paulson says he brokered this deal because the industry was struggling to cope with the scale and complexity of the default problem, since loans are owned by pools of investors whose interests vary.

•Empower agencies. Several major proposals involve allowing government-linked housing programs to provide more credit while the private banks are in recovery mode. Bush has expanded the ability of the Federal Housing Administration to refinance the loans of troubled subprime borrowers. Legislation, meanwhile, could allow FHA to insure bigger mortgages in high-cost states, and to insure more subprime borrowers if they pay higher premiums.

Federal Reserve Chairman Ben Bernanke has endorsed another congressional proposal: to temporarily allow Fannie Mae and Freddie Mac to fund high-end mortgages – loans for up to $1 million. The current limit for these government sponsored enterprises is $417,000.

In some high-cost cities, credit is now constrained as commercial banks tighten their lending standards.

With US taxpayers potentially on the hook if Fannie and Freddie get into trouble, another congressional proposal has been losing steam. This idea is to raise the caps on the total portfolios of loans that Fannie and Freddie can hold. Although the enterprises didn't invest heavily in subprime loans, they now face rising mortgage defaults just as regular banks do.

•Change tax law. Bush has proposed a shift so that Americans no longer face a tax on forgiven mortgage debts. One way this might help: It could encourage some lenders to modify loans for troubled borrowers in ways that the borrowers currently can't afford.

•Work through bank woes. Banks can act alone or collectively to absorb big mortgage losses in investment funds they set up. The Treasury hasn't offered any government bailout for these funds, known as structured investment vehicles (SIVs). But it has worked to set up a new rescue fund, funded by the banks themselves, that might facilitate the workout by buying some SIV assets.

•Slash rates. The Federal Reserve can continue to ease its target for short-term interest rates, as it has already been doing in the past few months. Critics say that "easy money" was a key cause of the current problems, allowing lenders to go wild a few years ago. But advocates say that at this point, it'll help the economy stay afloat.

•Shift bankruptcy rules. Allowing judges to revise loans might help more people keep their homes as they work out of bankruptcy. But critics say any forced changes in mortgage contracts could backfire, making credit harder to come by.

•Fix mortgage-industry flaws. Congress, regulators, and the private sector will work in the long term to improve the mortgage industry. Likely steps: a system of broker licensing, simpler disclosure of loan terms to consumers, and rethinking the pay incentives of people who helped a boom get out of control. Those players include appraisers, mortgage brokers, and the firms that provide investors with safety ratings on mortgage securities.

In all these steps, many proponents say a goal is to provide help, but not too much. Economists say that any taxpayer-funded bailout raises what's called the "moral hazard" of encouraging future carelessness by lenders and borrowers.

In the end, the solution to America's housing crunch will come as buyers and sellers work off the excess inventories now in the marketplace. Steps to avoid foreclosures can help keep those inventories from rising higher.

As home prices fall, meanwhile, homes will become affordable to more buyers.

"Lower prices will help clear [excess] supply," says Maury Harris, an economist at UBS in New York.