Housing: the key to economic revival?

The next bailout could focus on homeowners headed for default.

Momentum is building for the next bailout – not one targeted at big corporations but at the lowly borrower at risk of foreclosure.

The reason is that mortgage-relief measures undertaken in the past year have failed to stem a wave of loan defaults, and those defaults continue to play a central role in the current economic downturn.

The problem reached a stark milestone last week, as the Mortgage Bankers Association reported that 1 in 10 mortgage holders is either in foreclosure or at least a month late on payments.

President-elect Obama, the Democratic-controlled Congress, and the independent Federal Reserve are all considering new ways to stabilize the housing market.

Although economists don't see easy fixes, many say that reviving the economy now hinges not just on bank or auto rescues, not just on a broad new stimulus package from Washington, but also on targeted policies that give a boost to individual homeowners or home buyers.

"Policy steps should include foreclosure mitigation," says Mark Zandi, chief economist at Moody's Economy.com in West Chester, Pa. "It certainly helps people more directly than giving banks equity infusions."

And by helping to stabilize the housing market, such an effort should help restore order in the banking system and the broader economy, he says.

The costs of action could be large, but so could the cost of inaction, say experts on the housing problem, including Mr. Zandi.

Whatever the economic merits may be, the public has shown ambivalence – or outright resistance – to the growing scale of federal interventions aimed at preventing a deeper recession.

In one new NBC News/Wall Street Journal poll, just 27 percent of Americans approved of recent bailouts for firms in the financial sector, while 46 percent supported the idea of assisting the ailing auto industry.

In early October, 54 percent of Americans polled by CBS News said the government should help homeowners in trouble because their interest rates went up.

Republicans in Congress have become the voice for skepticism about a growing government role in the economy, voicing opposition this week to an auto-rescue deal worked out between the Bush administration and congressional Democrats.

Many Democrats, meanwhile, argue that the recent corporate bailouts have left ordinary homeowners behind.

But it's not just a matter of parsing justice between Wall Street and Main Street.

While there is wide agreement that some further reduction in home prices is likely in many metro areas, foreclosures can deepen the problem by creating a glut of homes on the market for cut-rate prices.

"Diminishing foreclosures is not entirely – maybe not ... even primarily – a matter of compassion for those who will be foreclosed," said Rep. Barney Frank (D) of Massachusetts.

Mr. Frank is chairman of the Financial Services Committee who will be influential in any new housing legislation.

Many of the investors and financial firms that hold troubled mortgages are themselves eager to modify loans, when possible, because they bear big losses when they foreclose in a weak market.

But a key obstacle has been the fact that most of the bad loans are packed into investment securities with a complex web of ownership.

Whether out of legal constraints or hesitation about how to serve the best interests of owners, the companies that service the loans haven't moved forward aggressively to rewrite the terms of loans.

The options for policymakers include:

•Changing bankruptcy law so that judges can rewrite loan contracts.

•Crafting new programs to encourage loan modifications. A formula might involve home-owners, lenders, and taxpayers all bearing some cost and sharing some gain if property values have risen when the owner eventually sells.

•Actions to expand demand for housing. Some housing experts say that because the troubled loans can be so hard to repair, it's more important to address the problem with a positive approach.

By bringing interest rates down, or providing tax incentives, more new buyers should enter the market.

That's the idea behind a recent Federal Reserve plan to become an investor in packages of mortgage loans.

"The case for more aggressive and comprehensive intervention in the housing sector seems compelling," economists at Goldman Sachs write in a new report. "Even after two years of declining prices, supply and demand remain significantly out of whack, with the share of vacant housing at record levels."